When it comes to stock market investing, different investors follow different approaches to gain from the market. There is no right or best way when it comes to investing. However, knowing all the ways through which one can invest will help you. In this article, we will discuss moat. It is one of the excellent ways to pick stocks for the long term.
What is Moat?
Have you read stories of kings, kingdoms, and wars? If you have read or seen any movie around it, you would have seen the castles of the ancient kings had a moat surrounding them. The purpose of moats was to ensure enemies could not invade the castle. The deeper and wider the moat, the higher the strength of the kingdom.
In a stock market, a moat has more or less the same meaning. When we say a company X has a moat – in a simple language, we mean that the business is such that it is difficult to replace. Hence it can continue to grow and stay strong for a long time.
What is not a moat?
Before we understand more about moats, we must understand what is not a moat.
Many investors often mistake moat with a competitive edge. One of the essential characteristics of companies having a moat is that it is difficult to replace its product or service. Most investors confuse moat with great operational execution, excellent management, high market shares, or quality products. While these are exceptional traits to have in a company from an investor’s point of view, they don’t give a company a moat. The reason is simple, none of these traits guarantees long-term success for the company. For example, a company has a high-quality product and profitable business, but if some other player can come and replicate the same, the growth of the first company will slow down. If such a thing can happen, the company does not has a moat.
People mistake companies with the largest market share as having a moat. It is not a moat. If you go through the list of companies with moats, you will find most of them are small or medium size.
If you plan to invest based on a moat, you should be very clear with the concept and not invest in a company with a false moat.
What gives a company a high moat?
We have talked about traits that do not indicate that a company has a moat. Are you wondering how to find companies with moats? Let us look at some moats you have to look for in companies to get excellent returns over a period.
Switching Costs – Businesses with a valuable competitive advantage of a high switching cost or product benefits of a better and new product have a moat. In layman language, if a company has products that even if a competitor creates today, the consumers won’t go to the new company because there is a high switching cost or the product is so good that consumers won’t be comfortable in changing company.
It gives the company pricing power. An example of such a moat is the software vendors. The company using software from software vendors does not prefer to switch to a new software because there are too many hassles in transferring the account. There are also training costs for the organization if it decides to use new software.
Intangible assets – If a company can have a product such that it becomes difficult for other companies to duplicate it, it can create a moat for its business. One way of achieving it is by having intangible assets that do not have a physical form but a product value. It could be patents, licenses, or brands that are hard for competitors to match.
Not all brands have a moat. A brand has a moat only if it increases the customers’ willingness to pay (even if the price increases) and attracts them to buy the product again and again.
Cost Advantage – There are some industries where the price is the most important factor for growth. In such an industry, if a business can find a way to offer a service or product to customers at a relatively low cost, then it can have a moat. If a company achieves a low price through process-based cost advantage, the advantage won’t last for long as competitors can copy the process. However, if it is a scale-based cost advantage, it will be more robust. Look for companies with scale-based advantages while doing research.
There are a lot of companies that have a moat in India. However, we will talk about the three in this article and leave our readers to look for more:
Asian Paints – The company was founded in 1942 and is engaged in the manufacturing, selling, and distribution of coating and paints related to home decor and bath fitting. The company has been successful in converting the paint commodity into a brand.
Avenue Supermart – Above, we talked about companies having a scaled-based advantage. Avenue Supermart fits in perfectly in the above example. The hypermarket set by the company has allowed it to set up a moat by providing products to consumers at a cost that is hard to beat by competitors.
Pidilite – It is a company that manufactures adhesives. The leading brands of the company have over 70% market share. There is some competition, but competitors can do very little when a company owns such a large percent of the market.
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