When you first start looking at a company in which to invest your hard-earned dollars, an important thing to look at is how it keeps competitors away and grows the business. This is known as competitive advantage or "moat." Good companies have it; not-so-good or downright bad companies do not. How can you judge?
Well, two things to ask yourself are: "How easy is it for others to do the same thing?" And "What would make a customer buy from these guys?" To illustrate, let's look at a relatively simple business and see whether it has a moat.
Privately held InMotion Pictures rents DVDs and players to travelers at airports. The customer picks up a DVD with or without a player before departure, watches the movie during the flight, and drops everything off at the destination airport. It has locations in 22 airports across the country. On the surface, it's a promising model.
How easy is it to duplicate? That depends. DVD libraries are not difficult to obtain, nor are the players. The airport rental space is relatively easy to get, but it could be expensive. And if a company could sign an exclusive contract with an airport, it could deter entry under the threat of high costs.
Why would a customer buy? With a little forethought, people could bring their own DVDs to play during the flight. As I write this, a gentleman sitting across from me in the Salt Lake City airport has done exactly that. Even though SLC has an InMotion outlet, he brought his own movie and player. Also, during the flight, people could read, talk, watch the clouds, or, my favorite, snore loudly.
Should the airport model continue to grow, there is nothing to keep companies such as Netflix
Companies with a moat, on the other hand, can keep out the competition and grow their customer bases. For instance, Coca-Cola
Fellow Fool David Meier wrote that the world's best investors look to understand the moat, even before crunching any numbers. So be a Foolish investor and look at how sustainable the company's model is. Many businesses do well without a moat, but the great ones have moats both wide and deep.
Foolish contributor Jim Mueller believes that every person's home is his or her castle, but we should leave the moats to the companies. Alligator upkeep is expensive. The Motley Fool has a disclosure policy , so he asked us to tell you he has beneficial interest in shares of Microsoft and owns shares in Coca-Cola.