Warren Buffett has made a name for himself by becoming a millionaire investing in the stock market. Very few people would debate the fact that he is the world’s greatest stock market investor. The “Oracle of Omaha” as he is often called has proven himself to be the best through a series of value investing tools that he has perfected through the years. As of February 2008, Forbes magazine called Warren Buffett the world’s wealthiest person. Buffett’s net worth is an estimated $62 billion.
We all know that Buffett is an amazing investor who has become one of the world’s top philanthropists as well, but why don’t we use some of his tips more in our own investment style? The truth is, by simply reading some of Buffett’s main quotes or transcripts from his speeches an investor can learn a whole lot of things that can be applied to their own portfolio.
One of the most important things that Warren Buffett has used in finding stocks that he believes are a good value as well as winners in the long run is the economic moat of a company. What does the term economic moat mean? An economic moat is a competitive advantage that is difficult to copy or emulate, which provides a significant barrier to competition from other firms. Buffett has often referred to an economic moat as being similar to a fortress or a medieval castle that one can not penetrate.
In what ways can a company build a moat? A very strong brand name is one way to have a tremendous moat. A couple examples of companies with brand names that give them a significant moat are McDonald’s and Coca Cola. It isn’t that these two companies don’t have competitors, but they have some very important competitive advantages over their competitors because of their economic moat. A cost advantage is another way to build an economic moat. Cost advantages help retailers like WalMart or Target have moat over their competitors. Both of these companies can acquire products much cheaper than other smaller companies in the same industry can, which gives them a great advantage.
Why is finding stocks with economic moats important to an investor? Stocks with an economic moat are stocks that have a continual competitive advantage. Buffett has used this measure for many years to find stocks that he buys while at a value price and he holds onto them for many years because he knows that this company will still have that same advantage down the road and there is nothing their competitors can do about that. Typically, if you can do so, history has found that if an investor can find a company that is just gaining an economic moat they will do very well. A young company who appears to be developing an economic moat through a distinct advantage over competitors is likely a very good stock pick.
What is the caveat in all this? Finding economic moat is a very difficult process. There is no clear way of measuring the moat of a company. The fact that a moat is so difficult to find underscores the importance of understanding what they are and being able to take advantage of times you find a company which has a significant amount of moat.
