MOATs

 Last week, we learned about the most successful investor of all time, Warren Buffet. In the next couple of articles, we’ll talk in more detail about the pillars sustaining his philosophy. In this occasion, it will be about MOATs.

What is a MOAT?

As previously explained, a MOAT is a durable competitive advantage, which allows companies to keep competition away from its market share. The importance of it relies in the retention and sustainability of existing customers and, in other cases, the benefit of expanding the business.

 Investing is all about the future and there’s the belief that by having a MOAT, a company’s cash flow projections become safer in some way. So, a true durable competitive advantage can help mitigate a small percentage of the uncertainty, inherent to the business of investing.

 There is always the debate of how many types of MOAT are there existent. Pat Dorsey, on his book “The Little Book that Builds Wealth” stated that there are ONLY four types of durable competitive advantage and we’ll stick to that thought.

High Switching Costs

Switching costs are those one-time inconveniences or expenses a customer incurs in order to switch over from one product to another, and they can make for a very powerful moat.

Examples:

1.      Switching Bank: It is commonly known how bureaucratically painful it is to change banks. There lives a MOAT.

2.      Switching Software Provider: Imagine that you run a business and have had the same accountability software for several years. If you switched provider, you’d had to migrate the database and teach every single employee the new software.

Network Effect

The network effect occurs when the value of a particular good or service increases for both new and existing users as more people use that good or service.

Examples:

1.   E-commerce Platform: As more sellers publish in the platform, a broader range of buyers will demand the platform’s products, which will in turn attract more sellers.

2.   Social Media: As more people uses the platform, more people will feel attracted to using it to not feel disconnected from society or because they know everyone uses it (Whatsapp for instance.)

Intangible Assets

Some companies have an advantage over competitors because of unique nonphysical, or “intangible,” assets.

Examples:

1.   Intellectual Property Rights (Patents)

2.   Brand Value: This comes from the power, awareness and attached quality of the business name. For example, people will pay extra for a PepsiCo product because everyone knows the quality.

Low-Cost Producer

As the name indicates, the advantage here relies on the business being able of selling at a lower price than competition.

Examples:

1.      Amazon. Their so developed fulfilment network allows charge delivery at a lower price than competitors.

2.      Walmart. The company belongs to the retail industry and its enormous scale allows it to keep costs low and charge lower for products.

Conclusion

This concept, popularized by Warren Buffet can be extremely powerful for investors since it can allow you to determine whether a company’s current earnings are more subject to volatility or not.

 Next issue will be about the importance of not overpaying. Subscribe if you would like to receive it at your E-mail!