Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Wide Economic Moat

What it is:

A wide economic moat is a significant competitive advantage that is extremely difficult to copy or emulate, thereby creating a barrier to entry for competing firms.

How it works (Example):

Castles were traditionally part city and part defensive fortress. The moat was a key part of this defense -- by surrounding the castle with water, the fortress was more difficult to penetrate. The wider the moat, the more difficult it would be to attack a castle's defenders.

Companies are not unlike medieval castles. A successful company will undoubtedly attract competitors. Patents, brand identity, technology, buying power and operational efficiency create moats that make these companies hard to attack.

Companies with wide economic moats operate business models that are difficult -- or in some cases even impossible -- for competitors to attack or emulate. Wal-Mart (WMT) is a perfect example of a company that has a wide moat. The company controls so much retail space that it's able to demand the lowest possible prices from suppliers. Because it would take decades of successful expansion for any firm to match Wal-Mart's tremendous size and scale, the company enjoys a sustainable advantage over its competition.

Why it Matters:

The presence and size of an economic moat correlates to a company's ability to sustain long-term profitability. Thus, many investors look at the size of a company's economic moat when choosing where to invest. The wider, the better. Measuring the actual size of the moat is difficult and often can't be done mathematically. However, the concept has a lot of support, particularly from Warren Buffett, who is often credited with coining the term.