This approach favors businesses with sustainable competitive advantages, promoting a more selective and thoughtful investment strategy. Understanding the specific moats of the chosen companies can offer insights into the potential resilience and growth prospects of the fund. A moat is a term borrowed from medieval castles that had a wide ditch filled with water around them to protect them from invaders. In business, a moat is a competitive advantage that gives you a sustainable edge.

Brand Moat

The results could be better pricing based on a structural long-term advantage, or more agile company development. In short, moats protect the market share and positioning of companies and facilitate the long-term sustainability of their business model, including the continued generation of profitability. The premise of an economic moat is that a wider moat makes it more difficult for an invader to reach the castle. Similarly, when a company has a wider moat, its competition may find it challenging to eat away at its market share. Businesses with at least one factor of Porter’s 5 forces model would possess a wide economic moat.

Economic what is a moat moats can be viewed as protective barriers against threats to the competitive positioning of companies, so stronger moats mean higher “hurdles” for the rest of the market. The final KPI that we’ll discuss is the free cash flow (FCFs) of a company, which is directly tied to the company’s capacity to spend on growth and re-invest into its operations. Thus, if a company has an economic moat, sustainable long-term value creation can be attained.

Your low prices lead to an increase in the number of customers buying lemonade from you (and not from your competitors).

What is an Real-Life Example of an Economic Moat?

1. From an investor’s view, it is ideal to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat.
2. This advantage serves as Zomato’s moat, making it challenging for competitors to overtake its position.
3. Suppose you have decided to make your fortune by running a lemonade stand.
4. After the creation of those products, Apple’s economic moat has consisted of its marketing, its design, and its user-friendly interface.
5. This concept, popularised by Warren Buffett, emphasises identifying companies with strong and defensible competitive positions.
6. No matter how many people consume it, you’ve done the same amount of work.

It is something that cannot be duplicated by another business (or, at least, not easily or legally). The idea of a defensive perimeter—like the castle moats of the middle ages—is pertinent to businesses of all sizes, from startup to global enterprise. By having some kind of defensive asset surrounding the (conceptual) perimeter of the business, the company then has something that will protect the core business and its assets. This is important, because as soon as the business begins making waves in the market, the much larger forces of incumbents and enterprises will begin to test those defences. High switching costs for customers are probably the most substantial moat.

Return on Invested Capital (ROIC)

In effect, the moat leads to sustainable profits over the long run and a more defensible market share, as the advantage cannot be easily mimicked by others. Efficient scale arises when a particular market is best served by a limited number of companies, giving them near-monopoly statuses. Utility firms are examples of companies with an efficient scale that is necessary to serve electricity and water to their customers in a single geographic area. Building a second utility company in the same area would be too costly and inefficient. Intangible assets are any proprietary assets that a company has that can’t be touched but can significantly impact sales.

1. Investors are also in a position to gain from companies with wide economic moats.
2. While doing so, you figure out a way to reduce your costs, while increasing your profits.
3. Just like in the traditional sense, a moat is the company’s line of defense that protects it from its competitors.
4. But Coke’s secret recipe (and strong brand moat) has kept it in business for 125+ years.
5. The notion that America was secured by two unbreachable moats, the Atlantic and the Pacific, was already about to be invalidated.
6. Economic moats can be viewed as protective barriers against threats to the competitive positioning of companies, so stronger moats mean higher “hurdles” for the rest of the market.

What Is an Example of an Economic Moat?

Everyone in the venture world has been waiting for months for the re-opening of the IPO window. After a record-breaking 2021 (1035 IPOs, beating the 2020 record of 480), 2022 saw a massive decline (181 IPOs), and 2023 has been a continuation of that trend. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Just because a company has high margins does not signify a moat, because there must also be an identifiable, unique advantage. Another could be to identify several niches that together would make sense, but from afar might not seem as easily put together.

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A competitive advantage is a temporary thing, and something that can be undermined and replicated by competitors. You are in a good spot if your clients love your product and it is difficult to replicate the tech (or not possible due to the existence of patents-protected IP rights) or the underlying dataset. You have the time to focus on growing your business without anyone competing for market share, or they do so with an inferior product that can’t win over time. Conversely, tech disruption is also the most efficient moat destroyer. An economic moat refers to a company with a long-term, sustainable competitive advantage, which protects its profits from competitors and external threats. A competitive advantage is a set of conditions or circumstances that give a company an edge over its rivals—usually by producing superior products and services compared to its competition.

It’s a very narrow moat, it will likely protect Sanrio into perpetuity. Many would argue that the network effect (often abbreviated to “nfx”) is the single most potent moat—especially in the tech space. Research even suggests that as much as 70 percent of all value in tech is created through nfx. In line with the stabilization of software valuations we discussed last time, revenue growth rates have also stabilized in the last three quarters. Growth for best-in-class startups is even accelerating, and new business activity is picking up (see charts below). A few upcoming tech IPOs, notably Klaviyo, Instacart, and Arm, have been announced.

Moat investing is an investment strategy that focuses on companies with sustainable competitive advantages, known as “economic moats”, which protect them from competitors. These moats can include innovation, differentiation, brand strength, cost advantages, technology, etc. Moat investing entails identifying and investing in businesses with such enduring qualities that can potentially maintain profitability and market dominance over the long term due to their unique advantages.

Whether it’s Apple, Nike, Peloton, Shopify, Twitter, or McDonald’s, the company has a moat around the business that protects it from the competition. At one stage all three of these businesses had massive, dominant moats. And yet Google, Facebook and Netflix, respectively, found ways to innovate around the moat, while building their own to defend against the counter-attack. Sanrio—the company that produces Hello Kitty—only really has one trick in its moat. It creates mascots that are cute, turns them into merchandise, and sells them.

A company that exists in a business where the startup costs are prohibitive for small entrants would also have a wide moat. There are several other ways in which a company creates an economic moat that allows it to have a significant advantage over its competitors. Some of the most common reasons behind economic moats are explained below. Economic moat-based investing is a valuable strategy of Bajaj Finserv Large and Mid Cap Fund. This fund navigates a diverse market and focuses on companies with economic moats.