The process of answering these fundamental questions about future economic profits and sustainable competitive advantages includes carefully researching the company and its industry. At Morningstar, our process includes analyzing the company’s financial statements, talking to its managers, visiting the firm’s operations when relevant, and reading industry publications. This fundamental analysis is a key component of understanding the outlook for a company’s future profitability and competitive forces. If we think ROICs are likely to exceed WACC in the future, and the company appears to have any of the five sources of competitive advantage, it’s possible that the firm does indeed have a narrow or wide economic moat. We next assess the company’s ability to generate positive economic profits 10 to 20 years into the future. Some companies may generate positive ROIC-WACC spreads today and for a few years into the future.

There are real concerns and competition to pay attention to and constantly weigh into our decision-making, but for now, I like where DKNG is now and where management wants them to be. There is still plenty of room for growth through new states and adding more betters worldwide considering the popularity of online sports betting. Consider DMart or Avenue Supermarts, which can generate such a volume of sales that they can negotiate the lowest prices from its vendors, resulting in low-cost products in stores. Either the cost of production is low, can meet the higher growing demand. Other companies may emerge as moat breakers, offering products or services that can challenge an existing moat.

• This article does not provide any financial advice and is not a recommendation to deal in any securities or product.
• Some companies have been given access to special authorization their competitors lack, like a special certification or an exclusive right to exploit specific mineral deposits.
• Casino operators with Asian facilities, such as Las Vegas Sands (LVS) and Wynn Resorts (WYNN), benefit from regulatory barriers to entry, giving Asian casino operators much wider economic moats than their U.S. counterparts.

It is often difficult to identify an economic moat when it is being created. It becomes more clear in hindsight, as the company reaches major heights. But still, if you observe closely, you will be able to identify https://1investing.in/ the significant advantage of a company. We’ve already seen how Walmart used the cost advantage to become the retail giant it is today. Similarly, companies create moats using various advantages related to cost.

What Is an Economic Moat?

However, the reality is this can take many years, allowing shareholders to enjoy potentially large returns by identifying companies with strong moats. A company that is able to maintain low operating expenses in relation to its sales compared to its peers has cost advantages, and it can undercut its competition by lowering prices and keeping rivals at bay. Consider Walmart Inc., which has an immense volume of sales and negotiates low prices with its suppliers, resulting in low-cost products in its stores that are hard to replicate by its competitors. Starbucks (SBUX) remains the dominant player in specialty coffee, and its brand commands premium pricing for what is truly a commodity.

ESPN will cut its marketing ties to promote DraftKings and Caesars (CZR) after announcing a deal to acquire PENN Entertainment’s (PENN) online betting business. ESPN paid $2 billion for the deal, which will help it reposition itself and launch its own online betting app, something it has debated for years. Anything that gives a company an edge or advantage over others is a moat. Colgate did lose some market share to Patanjali, but as per Statista, even in 2018, it had 53% of the total market share. Similarly, Maruti Suzuki has a market share of 51% in the India car segment.

For example, soft moats may be created by exceptional management or a unique corporate culture. While difficult to describe, a unique leadership and corporate environment may partially contribute to a corporation’s prolonged economic success. Moats are synonymous with high-margin businesses, but low margin companies can also have moats. This may be because they may be the lowest-cost operator in their sector.

On the other hand, if a company has a narrow economic moat, it means that the competitive advantage may not be sustainable. An example of a narrow economic moat would be the one created with patents that expire in a year or so. A company’s economic moat is a long-term competitive advantage a company has over the competing firms. An economic moat can be thought of as an intangible asset – you can’t see it, but they’re key in the success of a company. An economic moat is a durable competitive advantage that sets the company apart from its peers.

Buffett’s Moat: Google’s Competitive Advantage

In markets with a “winner takes all” dynamic (like e-commerce for example), size can provide protection in itself. Just think of TSMC, the leading maker of electronics chips, controlling more than 1/4 of the world market[1]. To keep with the castle analogy, a moat might be dried out, be filled with soil by assailants, and the castle finally breached.

Google’s biggest threat likely comes from significant changes that may take place in how Internet users behave. For example, the company’s effectiveness would be challenged if social networks became so popular that they curtailed the usefulness of Internet searches. Effective as its moat currently is, Google must remain nimble and prepared to change with its environment to maintain and widen its advantage. From this perspective, it is unlikely that Google’s brand contributes significantly to its moat.

Google’s Brand

A firm can generate positive net income, or positive accounting profits, without posting economic profits if it doesn’t reward equity investors for putting their money in the business. In the economic sense, moats are a company’s advantages that protect its profits and market share. Consider Wal-Mart Stores Inc., which has an immense volume of sales and negotiates low prices with its suppliers, resulting in low-cost products in its stores that are hard to replicate by its competitors. Patents and licenses allow companies to protect their production process and charge premium prices. Moats are a very powerful tool that can help a company to grow and stay highly profitable. Some of the best investors (like Warren Buffett) have made a career specializing in identifying companies with strong moats and paying a relatively low price for them.

Types of Economic MOAT for Companies

As you can see, a company’s economic moat represents a qualitative measurement of its ability to keep competitors at bay for an extended period of time. Those that do not expose themselves to the risk of being undercut. For example, Safestyle had a great model (or so it seemed) as it was highly profitable selling and installing windows. Then, other people started to realise that anybody could fit windows and also charge a high price while still undercutting Safestyle and many of its competitors. Naturally, this wiped out Safestyle’s profitability in the process. A company that exists in a business where the start-up costs are prohibitive for small entrants would also have a wide moat.

How are economic moats created?

In Google’s case, the company’s market share in search and in its Android mobile operating system is so strong that regulation looms as a possible threat to the company’s ability to maintain its strong profitability. Casino operators with Asian facilities, such as Las Vegas Sands (LVS) and Wynn Resorts (WYNN), benefit from regulatory barriers to entry, giving Asian casino operators much wider economic moats than their U.S. counterparts. The China market is an oligopoly, with only six licenses granted, and legalized gambling limited to the tiny, densely populated region of Macau; Singapore is a duopoly, with only two licenses.

Sources of Economic Moats

In the dictionary, a moat means a deep and broad dug that surrounds and protects a castle. Some consider excellent management as MOAT, whereas others consider growth and a better business environment as the MOAT for the business. To maximize your credit score increase you need to choose the best rent reporter for you. Learn all about the 12 valuation ratios that allow investors to quickly estimate a business’s value relative to its … Each week our editorial team keeps you up with the latest financial news, shares reading recommendations, and provides useful tips on how to make, save and grow your money.

The term comes from medieval castles that were defended by a deep moat, making the castle almost impossible to conquer. Some moats would be extra strong, for example very large and filled with water. Brand value is nothing but the perceived value of the company by the public. This brand recognition allows the company to charge a premium, without losing market share. This can be achieved through some form of unique value proposition, messaging, and culture.