We all have read many times in investing literature about investing in companies that have wide moat. We all also know that this term was made famous by Warren Buffett. What is this wide moat? In simple terms, it is some type of competitive advantage in its business. Competitive advantage in business can come from many different types, viz., brand, high switching cost, patents/IP/rights, ease of scalability, low cost producers, etc.
There are many companies that have many years building moats around their businesses. This moat makes it difficult for competitors to encroach upon their market share. Suffice to say, business with moat have sustainable competitive advantage. In general, companies with moats in their business are very good dividend growth providers. However, the opposite may not be true. Following are few examples of companies with moat that are also dividend growers.
For us, individual do-it-yourself investors, I am always intrigued by the process of determining moat. How do we really know what the moat is for any company that we invest in? We all read literature, listen to business honchos, and talking heads. Based on what we read we create a collage of this information and somewhere we find which company has wide moat. If were that easy, then there would be many more Buffetts, isn’t it?
To me, ability to determine wide moat and what price to buy are related. More importantly, these are closely tied to circle of competence. How can we individuals have circle of competency in all businesses or market areas? We have to depend upon literature to determine it.
On the same lines, how do we know that the company continues to enjoy the moat? After all, many of the companies that we thought had moat (and were dividend growers) got hit badly in last two years.
It is my belief that moat in a business is not permanent. It is management that ensures that their companies continue to enjoy the moat in market place. As mentioned earlier, you will find a quite a bit of literature on existing moat or past moat a company enjoys. The most difficult part is; how to monitor, or how to know whether the company continues to maintain its competitive advantage? It would be folly to think one will be able to identify it and sell at right time! Focusing on timing the market is never a good process and seldom successful.
In my viewpoint, the optimum approach is to manage this by minimizing the downside risk. This can be done by limiting the exposure (allocation) or limiting losses (event based selling).
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