How Wide Is Your Moat?

In the middle ages moats were built to defend castles from the attacks of enemies. Moats were quite useful in keeping attackers at bay and keeping the kingdom safe. This concept is critical, and not just for medieval castles, but also when assembling an investment portfolio. The wide moat concept applies to publicly traded companies and is a critical factor in a sound portfolio. Economic moats are structural business attributes that help companies generate high returns on capital for an extended period of time. There are several sources of economic moats, which we won't get into here, but think of companies like Walmart, Visa, & Lockheed Martin. The companies mentioned here have one or more critical factors that have created an economic moat and give the company a sustainable advantage over its competition. For example, Walmart has developed a procurement model that allows it to drive its costs down and deliver lower prices to customers. Some would argue Walmart's practices are detrimental to its suppliers, but for purposes of this discussion we only need to understand that Walmart is successful at keeping costs low, which provides a sustainable moat.

Warren Buffet once said, "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."

Obviously Warren Buffett has used this principle to acquire a vast amount of wealth and while the average investor doesn't have billions to play with the concept can be used by anyone. Morningstar, whom we are not affiliated with, does a wonderful job of assigning economic moat ratings to companies and there are actually mutual funds now established that only purchase stocks of companies with wide economic moats. The concept behind economic moat is not rocket science, the companies that fall into this category are typically more profitable than narrow moat companies, they have more sources of competitive advantage, and they have sustained their moats for a long period of time.

What does the wide moat strategy mean for your portfolio? Clearly, no one strategy is suited for all investors, but the wide moat strategy definitely has its place in a well balanced, properly allocated portfolio and over the long term (at least 10 years) you would be quite pleased with how a wide moat strategy performs in comparison to the S&P 500 Index.

So, what to take from this little tidbit? Slow and steady typically wins the race. The wide moat strategy is a long term, buy and hold play that isn't immune to some volatility, but our belief is that most average investors are better suited giving up short term risk and receiving long term gain.

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