(The guest author’s posts are entirely his own and may not always reflect the views of old school value)
Value Investors love to quote Saint Warren about “Economic Moat” (moat).
In business, I look for economic castles protected by unbreachable ‘moats’.
The simplest way to think about the company’s moat is to ask how easy it would be for another company to steal business from them.
Companies with a moat do have competition. However, try as they might, the competition just can’t break through. This can happen for a variety of reasons:
- Geography: We have our stuff in the right places and you don’t.
- Example: Union Pacific Railroad
- Infrastructure: We move our stuff faster, cheaper and more reliable than you.
- Example: Visa (V) or MasterCard (MA)
- Patents: Even if you wanted to, you legally can’t do what we do.
- Example: Apple (AAPL)
- Branding: We are trusted to do the job and you’re not.
- Example: Coke (KO)
- Economies of Scale: We’re so big, not using us will cost you.
- Example: Wal-Mart (WMT)
A company with a moat has a combination of these traits.
That doesn’t mean that these companies can do whatever they want. It also doesn’t mean their moats are impenetrable.
- Union Pacific Railroad still has to compete with trucks.
- Visa and MasterCard compete against cash, PayPal, Bitcoin etc.
- Apple’s patents are constantly challenged and becoming obsolete at a rapid pace.
- Coke can easily fall out of favor. Remember New Coke?
- Wal-Mart is in a constant price war with Target and other retailers.
But it still makes life easier when you have a moat. So as an investor, how do you figure out who has a moat and who doesn’t?
The first place I look at is Gross Margin.
Quick Look at Gross Margin
The formula for gross margin is simple: