The Importance of Widening Moat in Investing
Moats are good, but widening them is even better
In the realm of investing, the concept of a "moat" is pivotal. Coined by Warren Buffett, a moat represents a company's ability to maintain competitive advantages over its rivals to protect its long-term profits and market share. While having a strong moat is crucial, an equally, if not more important, consideration is the company's ability to widen that moat over time.
Short explanation
A moat can take many forms: brand reputation, patents, regulatory advantages, network effects, cost advantages, and high switching costs, to name a few. These factors help a company fend off competition and sustain profitability.
To delve deeper into the concept of moats with illustrative examples, here is an article I wrote 3 months ago.
However, in today’s rapidly changing business environment, a static moat might not be enough to ensure long-term success.
A dynamic environment
Industries are evolving at an unprecedented pace due to technological advancements, regulatory changes, and shifting consumer preferences. A competitive advantage that seems insurmountable today can quickly erode.
We saw a lot of recent examples: Intel, Nokia, Blackberry, AOL, Blockbuster to name a few.
This is why the concept of widening the moat is so vital. It signifies a company’s proactive efforts to strengthen and expand its competitive edges continuously.
Why Widening the Moat is Critical
Sustained competitive advantage: A widening moat indicates that a company is not just resting on its laurels but actively enhancing its market position. This could be through innovation, improving operational efficiencies, or expanding its product or service offerings. Companies that successfully widen their moats can maintain or even grow their market share over time, despite intensifying competition.
Adaptation to market changes: Companies that focus on widening their moats are better positioned to adapt to market changes. For instance, a tech company continually investing in R&D to stay ahead of technological trends is more likely to thrive compared to one relying solely on its existing patents. This adaptability ensures long-term relevance and competitiveness.
Improving profitability: Widening the moat often leads to improved profit margins. For example, a company that enhances its brand value through consistent quality and customer service can charge premium prices, thereby creating higher margins.
Some examples
Here are some examples of companies widening their moats.
Large caps. Microsoft, Crowdstrike, Schneider Electric, Waste Management, ASML, Intuitive Surgical, AppLovin
Small and mid caps. Bonesupport, Norbit, InPost, Dino Polska, Mader, Pro Medicus
How to identify companies widening their moat?
This list is non exhaustive.
R&D investments: Look for companies that consistently invest in research and development. High R&D spending often indicates a focus on innovation and future growth. The efficiency of R&D and benchmarking against competitors should also be closely monitored.
Strategic acquisitions: Companies that make strategic acquisitions to bolster their core business or enter new markets are actively widening their moats.
Expansion of products/services: Firms that continually expand their product or service offerings are enhancing their competitive edge.
Strong management: Leadership that emphasizes long-term growth and adaptation rather than short-term gains is crucial. Effective management will continuously seek ways to strengthen and widen the company’s competitive advantages.
Improving metrics. Improvements in metrics such as growth, return on invested capital (ROIC), and net profit margin can indicate a widening moat.
Gaining market share. An obvious sign of an increasing moat is gaining market share.
Conclusion
While having a moat is essential for any company to sustain its competitive advantage, the ability to widen that moat is what truly differentiates successful, resilient companies in the long run. Investors should look beyond the current competitive advantages and focus on how companies are enhancing and expanding their moats. Similarly, avoiding the narrowing of moats is essential, even if the stock price appears more enticing. By doing so, they can identify potential long-term winners in an ever-evolving market landscape.