Probably the most important thing which you should focus on while selecting a stock. What sort of a moat does the company have may well establish what should be your ultimate price you should be ready to pay for the business. Remember that the price you pay influence the return that you get in a big way.
Moat is probably some sort of a monopoly created over the years which helps the business to enable pricing power. It is some sort of a good will which can help the business you buy enjoy increasing returns over a period of time. Warren has an outstanding comparison for what can be called a moat- A business with a moat is some sort of a castle which is guarded so effectively that it cannot be accesed so easily. Similar with a business a moat has such intangible assets at its disposal that it can set and control a market upto some extent. It does not have to get in a rat race of constantly lowering prices thereby increasing only the quantitative share of revenues and not the qualitative ones which means that by reducing prices you let your margins fall and rely mostly on the volume growth to drive your business. Good businesses which have a long term sustainable moat under their armory deserve to paid more than those business which don’t have any such moat.
If we were to give you an example of moat it is that sort of a boy/girl in a college classroom which has admiring points other than his looks(i.e for a business other than price). The person in focus does not have to everyday on looking great (not to reduce prices everytime) rather he can focus on such other points to enhance himself (widening his moat). He doesn’t have to get himself envied of the new handsome looking boy in the class, he already has such factors under his control that he can get the new boy influenced by him.
Warren adequately describes the moat thing on repeated instances with one of his permanent holdings (he intends to to sell his permanent holdings never). i.e Coca Cola which is one one of the largest producer of coke which is just black water without the name of Coca Cola on it. Do watch this video for an excellent talk on moat (if the video doesn’t play for any reason you can go to YouTube directly by clicking on the vidoe headline)
The main question which arises here is how are moats formed. Moats can form maybe due to a variety of different reasons
- Distribution Power
- Some sort of a goodwill in the minds of the consumer
- Dedicated Management and employees of the company
- Experience (a very old company might have experienced a lot of business cycles and might have effectively come through them)
- Locational Advantage (if a toll bridge is the only way to use the river you have to use it and pay the toll- this example again given by Warren Buffett)
- Many other reasons which can be better looked at on a case by case basis
I guess moats are even harder to form than babies as they generally take longer than 9 months. Moats are formed by some extremely novel product which may not necessarily be the next Google or silicon valley. We know that all companies in Silicon Valley do have a sureshot and a durable moat until the time you can watch the clock which maybe somewhere around you. The main problem in technological companies is that consumers get shifted so easily in it. You may never know that maybe tomorrow morning you see a app out of nowhere on the top of charts in your app store. You may also find it useful and shift to it. Once Facebook was the talk of the town, once instagram and now its snapchat. Imagine how many most downloaded social apps have you downloaded in your phone. Such type of high competition is for sure not going to happen in the case of Coca Cola. Even if someone gets the exact taste it will take quite long for that business to reach the distribution network and the brand name that Coca Cola enjoys. Coke thus virtually controls the market. Just imagine how many options to Coca Cola can you think of if you where to maybe pepsi. But i do believe that the market is large enough to sustain both. Now just think how can options to chatting apps can you think of surely many which may be perfect substitutes of each either now or either sometimes in the near future as everything gets imitated so quickly there.
Now thats the benefit and viability of a moat. Remember a moat can be called a moat only if it is sustainable. Calling a short bounce in sales a moat is like testing an Air Conditioner when there is snow outside.
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