You might have heard the term economic moat a lot if you are new to stock market investing. Moat is a term used a lot between investors to gauge the strength of the company competitive advantage. This post will tell you everything you need to know about Economic Moat and how to measure it.
What is Economic Moat
Economic Moat is the ability of a company to protect itself from other competitive companies in the same market segment. A company’s moat enables a company to stay in the market and capture a significant percentage of consumers or users of that company products.
The term Economic moat was invented by Warren Buffett, which refers to a castle with deep trenches surrounding the castle and filled with water to protect the castle from invaders. A company has a wide moat when it can capture a massive market share.
Company moats do not stay the same; a company can gain a new moat or lose a moat. Therefore, moats are distinctive to a company, and they can change based on their ability to cope with recessions and emerging markets.
There are types of economic moats; to invest in a company, you must identify its moat.
How to Find and Invest in Stocks With Wide Moats?
The following are examples of wide economic moats:
- Brand: Companies you are willing to pay more for because you trust the brand. Coca-Cola is a good example of a Brand company because they can raise their prices, and people will still pay for it.
- Secret: Companies that have the authority or trading secret that makes it very difficult for competitors. Pharmaceutical companies that develop vaccines and drugs are companies that have a secret.
- Tolls: Companies that have control over the market and collects bills or tolls for services, such as Utility companies.
- Switching: Companies that are too hard to switch from. Companies such as Apple is too difficult to switch from.
- Price: Companies that price their products so low that it is difficult for other companies to compete with, such as Walmart.
How to identify a strong company moat
You can identify if the company has a strong economic moat by checking the four growth rates if they have consistent growth bigger than 10% for the past 5-10 years.
- Sales growth rate: Total annual sales, you can find in the company income statement. It is also known as the Topline.
- Earnings per Share (EPS) growth rate: Business profit per share, also known as the bottom line found in the income statement.
- Book Value per Share (BVPS) growth line: Ratio of total equity divided by the number of shares outstanding. You can find Book value in the company balance sheet.
- Free Cash flow (FCF) growth rate: The amount of cash the company has after operations which it can be found in the cash flow statement.
