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Economic Moats Checklist

Economic moats protect companies from competition, enabling them to earn more money for a long time and therefore making them more valuable to investors.

Economic Moats Checklist

  • Finding a Business with Moat

     

    Start looking for companies with consistent and above average operating performance.

    • Return on total assets

       

      A steady return of 7% or more indicates effective deployment of resources across the enterprise.

    • Return on equity

       

      A stable return of 15% or more with little or no debt indicates effective use of shareholders’ funds.

    • Return on invested capital

       

      A solid return of 20% or more is a satisfactory return on investment.

    • Operating margin

       

      A high and consistent operating profit margin indicates the firm’s pricing power.

    • Free cash flow

       

      Good year-on-year excess cash generation. Unless it is positive, expansion can only be financed by increased debt or equity.

    • Earnings growth

       

      The expected growth rate for the business over the medium term. This gives a feel for future value.

    • Moat sectors

       

      Some industries are easier to create a competitive advantage than others. Ideal industries are Media, Business Services, Financial Services, Consumer Goods and Health Care Services.

  • Intangible Assets Moat

     

    The goodwill that keeps on giving.

    • Strong brand

       

      A brand that can charge a premium price relative to similar competing products without losing market share or can promote regular repeat business.

    • Patents

       

      A diverse portfolio of patents and a track record of creating successful patented products.

    • Regulatory licenses

       

      Regulations that limit competition. A large number of small-scale rules are better than big rule as large rule can be changed.

  • Switching Costs Moat

     

    A business with lots of stick customers.

    • Cost and complexity

       

      The cost and hassle of switching to a competitor’s product or service are more significant than the benefits.

    • Tight integration

       

      The company’s products or services are tightly integrated with its customer’s daily operations.

  • The Network Effect Moat

     

    A large network of assets or customers.

    • Large user-base

       

      The value of the company’s product or service increases with the number of people regularly using it. E.g. Credit cards and online auctions.

    • Information sharing or connected users

       

      A business with information sharing products or connecting users together.

    • Operate a closed network

       

      Is the network open up for other participants?

  • Cost Advantages Moat

     

    The most efficient operator in the industry.

    • Better location

       

      The company is close to its customers enabling it to deliver a cheaper and more superior service.

    • Unique assets

       

      The business owns a unique world-class asset that is hard to replicate.

    • Greater scale

       

      The company can purchase goods at a bigger discount price.

    • Cheaper process

       

      The company has the most efficient and lowest cost process in the industry.

  • The Size Advantages Moat

     

    Big fish in a small pond make big money.

    • Large distribution network

       

      The business owns a large distribution network that takes a long time and a lots of money to build.

    • Niche market dominance

       

      The company is bigger than its competitors and dominate its niche markets.

    • Manufacturing scale

       

      Making more goods with the same fixed costs.

  • Mistaken Moats

     

    Don’t be fooled by these illusory competitive advantages.

    • Single great product

       

      Produces great short-term results until an innovated product comes along from a competitor.

    • Large market share

       

      Technology and market trend can dissipate market share very quickly if the company failed to maintain its competitiveness.

    • Great management

       

      People eventually do move on.

  • Moat Fortification

    • How strong is the moat and how long it will last.

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