“𝙉𝙤 𝙛𝙤𝙧𝙢𝙪𝙡𝙖 𝙞𝙣 𝙛𝙞𝙣𝙖𝙣𝙘𝙚 𝙩𝙚𝙡𝙡𝙨 𝙮𝙤𝙪 𝙩𝙝𝙖𝙩 𝙩𝙝𝙚 𝙢𝙤𝙖𝙩 𝙞𝙨 28 𝙛𝙚𝙚𝙩 𝙬𝙞𝙙𝙚 𝙖𝙣𝙙 16 𝙛𝙚𝙚𝙩 𝙙𝙚𝙚𝙥. 𝙏𝙝𝙖𝙩’𝙨 𝙬𝙝𝙖𝙩 𝙙𝙧𝙞𝙫𝙚𝙨 𝙩𝙝𝙚 𝙖𝙘𝙖𝙙𝙚𝙢𝙞𝙘𝙨 𝙘𝙧𝙖𝙯𝙮. 𝙏𝙝𝙚𝙮 𝙘𝙖𝙣 𝙘𝙤𝙢𝙥𝙪𝙩𝙚 𝙨𝙩𝙖𝙣𝙙𝙖𝙧𝙙 𝙙𝙚𝙫𝙞𝙖𝙩𝙞𝙤𝙣𝙨 𝙖𝙣𝙙 𝙗𝙚𝙩𝙖𝙨, 𝙗𝙪𝙩 𝙩𝙝𝙚𝙮 𝙘𝙖𝙣’𝙩 𝙪𝙣𝙙𝙚𝙧𝙨𝙩𝙖𝙣𝙙 𝙢𝙤𝙖𝙩𝙨” — Warren Buffett
Buffett also says that “A truly great business must have an enduring moat that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business castle that is earning high returns”
There is no one formula to measure business moats.
The all encompassing metric that comes closest is ROIC (or ROE for financial services) — a business which is able to demonstrate high ROIC for a significant period is able to do so because it has moat.
The following characteristics provide formidable barriers against competition (in other words these are key sources of moat)
– [ ] 𝗖𝗼𝘀𝘁 𝗔𝗱𝘃𝗮𝗻𝘁𝗮𝗴𝗲
e.g., Costco (US retailer) procures (and sells) at the lowest cost
Netflix incurs negligible incremental cost in onboarding a new subsriber
– [ ] 𝗕𝗿𝗮𝗻𝗱 𝗣𝗼𝘄𝗲𝗿
e.g., Apple is able to charge a premium because of its brand value, which is synonymous with innovation and quality
Btw, how do you value a brand? — topic for another post
– [ ] 𝗗𝗶𝘀𝘁𝗿𝗶𝗯𝘂𝘁𝗶𝗼𝗻
e.g., Large FMCG and beverage companies have presence in the remotest of areas
– [ ] 𝗡𝗲𝘁𝘄𝗼𝗿𝗸 𝗘𝗳𝗳𝗲𝗰𝘁𝘀
e.g., Hospitals are encouraged to tie up with Health Insurers that have a lot of customers. In turn, customers are encouraged to go for health insurers that provide coverage across multiple hospitals. This creates networking effects for the health insurer
Moreover, digital platforms like Meta, LinkedIn, Uber have a lot of networking effects as well
– [ ] 𝗦𝘄𝗶𝘁𝗰𝗵𝗶𝗻𝗴 𝗖𝗼𝘀𝘁𝘀
e.g., Switching from one IT service provider to another is a lot of cost and effort for a company. This creates a switching cost moat for the IT provider
– [ ] 𝗣𝗿𝗼𝗱𝘂𝗰𝘁 𝗗𝗶𝗳𝗳𝗲𝗿𝗲𝗻𝘁𝗶𝗮𝘁𝗶𝗼𝗻
Can you think of companies offering differentiated products or services? Differentiation could result from selling at lower cost vs peer for similar quality products
What are some of the other sources of moat?
In the linked video, I discuss the sources of moat and evaluate an Indian health care provider Narayana Hrudayalaya (which is foraying into health insurance) against each of these sources.
Analyzing these sources are key to the research and investment thesis of any business.
