Economic moats of evaluating stocks or companies

 

What is economic moats

What is an 'Economic Moats'?

The economic moats refers to the 'competitive advantage' a firm or company has over its peers.

It is a structural feature that help a firm or company shield profitability.

Economic moats help company's to protect profitability and market share.

It is a strong barriers against antagonism from others companies or firms.

If there is no moat, competition will be increased.

Anything that helps the firm in protecting its profitability its peers is a moat.

Warren Buffett said that,

"A good business is like a strong castle".


Why is an Economic Moats important for investors?

When a investor invest his/her money any business then he/she expected good return from the company.

Economic Moats help the economy to generate consistent profits over the years.

To generate large amount profits, a company should be achieved competitive advantage or moat.
If there is no moat, competition will eventually drive the return on capital down to the cost of capital or even lower.

Competitive advantage enable to earn sustainable profits for a prolonged period. 

To consistent profit to be considered as moats,the competitive advantage must be viable. It can be helpful to earn profit for companies well as investors over the years.

How to create an 'Economic Moats'?

Economic moats might take years to acquire for some companies.

If a company has economic moats, the company will enjoy profitability over the year.

Distribution Network:

Some products are dependent on the distribution network for their success.

It is costly and time consuming for a small company to establish healthy distribution network.

An established distribution network which help ensuring that any new product is easily available on the shelves, throughout the country. 

More customers indicates higher revenue. Distribution network plays important role to its competitors.

So, huge distribution networks protect its peers.

High Switching Cost:

Switching cost refers to the time, cost and inconvenience involved for the customer in Switching to product or service offered by a competitor of a company.

Suppose, most of people use Facebook or Instagram, they don't go for other social media platforms. Because all of the individuals and family are on it too.

In that case, Switching cost are higher in the case of Facebook or Instagram, which act as a strong moat that ensures repeated business.

Cost Advantage:

Customers are attracted to quality at lower price.

A company can price its products lower by keeping a check on its cost. Some companies enjoy a natural cost advantage such as proximity to raw material, low labour cost in the region.

Wherein the product differentiate is minimal and the consumer is extremely cost sensitive.

Regulatory Licenses: 

Regulatory license takea lot of paperwork, capital adequacy and numerous licenses to start new business like banks, rating agencies etc.

There are lots of entry barriers in starting a business. It helps existing players to thrive as they protect from new competition due to lots of barriers.

A lot of business is valued because of the license. So, licenses act as a deterrent for new players, its ensures stable growth. 

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