This Elon Musk Quote Is Something Every Investor Needs to Hear

Tesla's (TSLA 1.52%) quarterly earnings calls break the mold -- they're actually interesting to listen to. The first quarter of 2018 didn't disappoint as CEO Elon Musk talked about an unwieldy machine on the production line dubbed "fluffer bot," used words like cockamamie, and created controversy by dismissing Wall Street analysts and turning Q&A over to YouTube channel operator Galileo Russell.

One of the more interesting moments from the call came when Russell asked Musk why Tesla's charging station infrastructure isn't being used as a moat against other automakers. Musk's reply:

First of all, I think moats are lame. It's nice sort of quaint in a vestigial way. If your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation. That is the fundamental determinant of competitiveness.

Musk's comment, while seeming flippant, holds a valuable lesson for investors.

Image source: Getty Images.

What's a moat?

Just as a moat offered a castle protection in times past, an "economic moat" refers to a competitive advantage a business has over its peers. Things like low-cost products or services, convenience of use, or brand recognition can create a protective moat for a company. Some classic but no longer as relevant examples are Walmart (NYSE: WMT), Coca Cola (NYSE: KO), and IBM (NYSE: IBM).

Times change, though, and moats lose their effectiveness (ask the above-listed companies). It might be shifting consumer trends, changing economic conditions, or competitors finding another way into the castle. Musk is alluding to that last point. Boiled down, the argument is that, in today's business environment and that of the foreseeable future, the best defense is a great offense. Companies focused on maintaining what they already have will be quickly overrun by competitors, but the company that can innovate faster than all the others won't need a moat at all.

Warren Buffett, the man who popularized and has profited from moats, took exception to the comment. Buffett adduced some of Berkshire Hathaway's (BRK.A -0.29%) (BRK.B 0.07%) subsidiaries like insurance company GEICO and See's Candies.

Not to be outdone, Musk said he will be starting a candy company.

Time to reinvent the moat?

All humor aside (though Musk said he was serious about the candy venture), this is an important consideration for investors. There are plenty of companies with moats, and investors can profit from owning such stocks. However, this isn't enough to hang one's hat on. The pace of technological innovation and changing consumer activity has created an environment where disruption is a powerful force. Case in point, here were the top-10 companies in the S&P 500 index a decade ago compared with today.

Chart by author. Data source: ETF Database, State Street Global Advisors, and Yahoo! Finance.

This list changes year to year, nor does it show the whole picture. There are hundreds of other companies that were a fraction of their current size, or didn't exist at all, a decade ago that are now on everyone's radar -- including Tesla. It nevertheless illustrates this point: Innovation has become the most powerful business tool to achieve growth and stave off competitors. That's why the companies that currently sit at the top of this list continue to be known as innovators looking for the next big thing in the world of business.

That doesn't mean moats are dead; they're not "lame," either. Rather, it's time for investors to rethink what a defensible position is. It's all about innovating before an upstart competitor does it first.