How to Find and Invest in Stocks With Wide Moats
Look for resilient stocks with a strong competitive advantage
We’re all familiar with tales from the Middle Ages that featured castles surrounded by large moats, fending off hordes of knights and enemy armies.
These moats were designed to keep out intruders, and the longer and deeper the moat, the more protected the castle would be.
Did you know that companies also have moats? And did you know that learning about these moats can help you as an investor?
They aren’t physical moats, but metaphorical ones. And as investors, we can examine these moats to determine whether a company can withstand tough times and report strong financial performance over time.
In investing terms, the word “moat” usually refers to a competitive advantage. To say that a company has a “wide moat” is to say that it has a unique edge over other companies in its industry. In a broader sense, it can be used to describe something in the company’s business that serves as a protective barrier.
Examples of Wide-Moat Stocks
For the average investor, an ideal stock is one that offers steady growth over time and an ability to withstand market downturns and tough economic times. Long-term investors should look to invest in companies that are resilient in the face of competition and changing conditions.
The legendary investor Warren Buffett is often credited with using the term “moat” to describe these companies. In he is quoted as saying: “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
So what are some high-profile stocks that are known to have a wide moat? Amazon could definitely fall into this category. In 2017 the company now dominated the e-commerce space, in the U.S., according to some projections. It has unparalleled built-in efficiencies, warehouses, and supply chain systems that make it a very tough competitor for both online and traditional retailers.
Walmart is another company often praised for its wide moat. As the largest brick-and-mortar retailer (with a large e-commerce operation as well) it has a big edge in its ability to offer a large number of products at prices that undercut the competition. Moreover, because it is a discount retailer, it is in the unique position to see strong sales when the economy is doing well and when people have less money in their pockets.
Identifying Wide-Moat Stocks
There are some companies, such as Walmart and Amazon, that are easy to identify as having wide moats. But moats are not always as obvious, especially with firms you may not be as familiar with.
If you are looking to find stocks with wide moats, a company’s past stock performance and financial statements can help. When examining a company, there are a few things to look for:
- Earnings Performance During Bad Economic Times
Take a look at whether the company still seems to be doing well, even when the broad economy is struggling. This may be an indication that there is something about its business that allows it to remain resilient in the face of tough times.
- Cash on Hand
Many companies make a choice to keep a lot of cash rather than reinvest it or pay dividends. Some may argue that the company should spend its cash or give it back to investors, but having lots of cash on hand does give a company a strong cushion if revenues don’t meet expectations.
- Financial Performance Compared to Competitors
First, identify the company’s key competitors. Then, compare their revenues and profits. If there’s a big difference between your company’s earnings and those it competes against, you can say it has a wide moat.
- Dominance of a Single Product
Apple is considered to have a wide moat because sales of its iPhone far outpace that of any other company. Intel has dominated the semiconductor industry for years because its chips are commonly used by most computer manufacturers. The popularity of these products gives these companies a moat, protecting them against competition and sometimes even the failure of its own other products.
It’s not uncommon for one company to have a unique patent on a product or technology that other firms have little choice but to use. This can be a powerful driver of revenues that competitors can’t match.
- Name Recognition
Is the company practically synonymous with the industry? Do customers instinctively use its product or services simply because they are recognizable and have been around forever? Sometimes, simply having a long, reliable presence in the marketplace can give a company a strong competitive advantage.
A company with a wide moat is usually a company worth investing in. It usually means the company is profitable in good times and bad, resilient in the face of bad news, and dominant in its industry. Knowing where to find companies with wide moats and how to invest in their stocks can be a key part of building a strong investment portfolio.