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Measuring the Moat

“We like stocks that generate high returns on invested capital,” Warren Buffett told those in attendance at Berkshire’s 1995 annual meeting, “where there is a strong likelihood that it will continue to do so.”

“I look at long-term competitive advantage,” he later added, “and [whether] that’s something that’s enduring.”

According to Buffett, the economic world is divided into a small group of franchises and a much larger group of commodity businesses, most of which are not worth purchasing.

He defines a franchise as a company whose product or service (1) is needed or desired, (2) has no close substitute, and (3) is not regulated.

Individually and collectively, these create what Buffett calls a ‘moat’ – something that gives the company a clear advantage over others and protects it against incursions from the competition.

The bigger the moat, the more sustainable, the better it is.

Buffett says…

The key to investing is 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.

He suggests that buying a business is akin to buying a castle surrounded by a moat. Buffett wants the economic moat around the businesses he buys to be deep and wide to fend off all competition. He goes one step further, noting that economic moats are almost never stable; they’re either getting a little bit wider, or a little bit narrower, every day.

So he sums up his objective as buying a business where the economic moat is formidable and widening.

As he wrote in his 1994 letter to shareholders…

Look for the durability of the franchise. The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.

Now, as much important as they are, moats are fairly rare and come from a variety of things, such as brand, intellectual property, scale economies, a regulatory advantage, high customer switching costs, or some sort of network effect.

Through this page dedicated to moats, I will share the resources that explain the concept of moats, and also to help you develop a systematic way to explain the factors behind a company’s moat.

Timeless Resources on Moats

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