Q: I've been reading about Warren Buffett's investing style, and one concept that he's mentioned often is looking for sustainable competitive advantages, or a "wide moat," in stocks he buys. Aside from looking at Buffett's portfolio, how can I find stocks with wide moats?
First, to help understand the term "wide moat," think about a castle in the Middle Ages. If the castle had a wide moat, it wasn't easy for invaders to get in. Similarly, if a company has a durable competitive advantage, it's not easy for competitors to steal its market share.
These competitive advantages come in several forms, and if you can identify one or more of these in a company, it could be worthy of a closer look for your portfolio.
Cost advantages are an example. This can mean that a company can profitably sell a product at a lower cost than its competitors, or that it has a lower cost structure than its peers, or that it has the ability to charge more than rivals for the same type of product. Think of companies like Coca-Cola. Its large and efficient distribution network allows it to move its products all over the world in a cost-effective way, and its brand power allows it to charge more than other soft drink brands.
Network effects can be another extremely durable moat. Consider Facebook: The social network has more than 2 billion users, and if people want to keep up with their friends, they almost have to use Facebook.
There are several other advantages you can look for as well. For example, if a company owns valuable intellectual property like patents, it can be a big advantage. If it's expensive to stop using a company's product in favor of a competitor (high switching costs), it can also be a major advantage.
If you apply these concepts to stocks you have your eye on, you'll be able to separate those companies with great businesses now from companies that will still have great businesses tomorrow.
