Health Info

May 16, 2022

What is an Economic Moat? How to identify Economic Moat?

Companies that own patents have a strong economic moat that can generate income for up to 20 years. For example, due to the various patents that Qualcomm holds in the communications industry, it gets royalty payments for any phone manufactured and sold anywhere in the world. This royalty income is a significant contributor to the company’s annual revenue of around US$6 billion. The average retail investor does not have the time or the resources to study multiple industries in-depth, putting him at a disadvantage. A major example of misunderstanding moats is the assumption that brands equal moats.

For example, Pharmaceutical companies earn millions due to their patent drugs. Investors often wonder what an economic moat means and if it can be a factor one considers to pick the right stocks. So, let us understand an economic moat, why it’s crucial, and how one can select companies to invest in. Product moat is when a company has a product with a significant market share. The book acknowledges that sustaining advantages for long periods is rare by assigning a wide moat rating to only 200 companies globally. A sizable company will be able to achieve economies of scale, allowing it to produce more units with lower input costs.

moat in business

In a broader sense, it may refer to anything in a company’s operations that can safeguard it in the long run. You may use these moats to determine if a firm can endure adversity. Financial reports of companies must be followed regularly to know the market condition of the company at all times. TTK Prestige is a dominant brand in the pressure cooker segment. The total addressable market is not huge and the effect of this can be seen in the growth in revenues of the company which seems to be plateauing in the last few years.

Switching costs

If you are a platform business, all sides of the platform are your customers. Companies with products on your platform should be treated as customers not suppliers. A score above 20 indicates a very favourable business environment and below 10 should be a reason to consider diversification. If your score is 2 or more higher than that of your competitors, it indicates that you are successful in building a moat around your business. For example, you can focus on specific customer segments where an aspect of your solution lowers buyer power, such as product design of Apple phones.

Economic Moats: Why one must consider them when picking stocks

Companies with considerable cost advantages can undercut any rival attempting to enter their sector, pushing the competition to quit or at the very least limiting their growth. An economic moat is a structural business characteristic that allows a firm to generate high returns on capital for an extended period. It acts as a barrier that protects a company from competition. Naturally, this would result in competition because capital flows to the areas of highest potential return.

In a similar way there are a lot of small and medium businesses who use the concept of float to arrange their investment fund. Few more examples are, Gift cards, loyalty programs, subscription businesses and prepaid contracts, etc. We collect, retain, and use your contact information for legitimate business purposes only, to contact you and to provide you information & latest updates regarding our products & services. We do not sell or rent your contact information to third parties. If you are inspired by Warren Buffet’s journey and his belief in the concept of an economic moat, call up your broker right away to figure out your next investment. Let’s say a particular geographical area is rich in coal, and a couple of companies already have established their capital- intensive operations to mine the coal.

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Companies such as telecommunication and IT often have high switching costs which result in higher customer retention. Back testing data for a longer period would have offered a variety of insights and heightened the appeal of this concept. No need to issue cheques by investors while subscribing to IPO. Just write the bank account number and sign in the application form to authorise your bank to make payment in case of allotment. No worries for refund as the money remains in investor’s account.” When competitors switch their preferences from one company to its customer, a huge disruption cost occurs, and this is very high for customers of a company with an economic moat.

In modern times, companies also need to defend their market share from competitors by using their competitive advantage favorably. This type of competitive advantage is known as an economic moat. Fundamentally, the greater and more sustainable a firm’s competitive edge, the broader is their economic moat. By creating a legitimate edge, a company can create a broad enough economic moat to successfully restrict competition within the market.

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