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Stepan Lavrouk
Stepan Lavrouk
Articles (508) 

Warren Buffett: How Do Businesses Build an Economic Moat?

The Oracle of Omaha considers a moat an important characteristic for any business he invests in

June 30, 2020 | About:

It’s a well-known fact that Warren Buffett (Trades, Portfolio) likes business with durable competitive advantages that aren’t shared by the other businesses in the field - what he likes to call an economic moat. This was a departure from the strategy he used as a younger investor, when he would look for "cigar butt" businesses that had small amounts of value left in them. At the 2002 annual Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) shareholder meeting, Buffett explained how companies develop moats.

The road to a moat can be a winding path

Different companies develop moats at different rates. Generally speaking, the newer the industry in which the business operates, the faster it can develop a competitive advantage. For instance, Microsoft (MSFT) was able to build a strong brand around its Windows operating system and suite of Office software products relatively quickly because there wasn’t a strong competitor in the space beforehand. On the other hand, if you are operating in a mature sector, it will be harder to disrupt an established player who has been there for a long time.

For instance, Coca-Cola (NYSE:KO), one of Buffett’s favorite investments, was originally founded in 1892 and had thousands of different competitors for decades, all of which produced more or less the same kind of cola drinks. The real catalyst that drove the Coke brand forward and solidified its moat happened during World War II, when General Dwight Eisenhower made Coke the de facto official drink of the U.S. military. After the war, Coke was so ingrained in the minds of consumers that it became one of the best-selling brands of all time - and it helped that the U.S. military had assisted in the construction of Coke bottling plants in Europe. But it took a long time for Coke to gain this dominance, as Buffett explained:

“It takes a long time in certain types of products, but I can see some areas of the world where a huge competitive advantage, built in a short period of time [can take hold]. In terms of animated feature length films, Walt Disney did that. He got there fairly quickly.”

Buffett’s Berkshire partner, Charlie Munger (Trades, Portfolio), added that moats can be lost very rapidly too, but that speed will also depend on the industry that the company operates in:

“There are a lot of different models that create a sustainable competitive advantage. And there are also some models where you can lose it very fast - just ask Arthur Andersen [Enron’s auditor]. That was a very good name in America for not very long ago. It would be harder to lose the good name of Wrigley’s Gum than the good name of Arthur Andersen. The great trouble with the investment process is that they [competitive advantages] are so damned obvious that the stock usually sells at a premium!”

As Munger put it so eloquently, it’s not really enough to just identify a business with a moat - you need to find a good opportunity to buy it at a relative discount to intrinsic value; and the more obvious an advantage, the less likely that it will be selling at a discount.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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