Moats

"Knights, the gift of freedom is yours by right. But the home we seek resides not in some distant land. It's in us, and in our actions on this day! If this be our destiny, then so be it. But let history remember, we chose to make it so!"
--Arthur Castus (King Arthur)

Years ago economist Joseph Schumpeter (1942) famously described capitalistic markets as processes of 'creative destruction' where entrepreneurial innovation continuously obsoletes the status quo in favor of more valuable forms of output that please customers. Thriving in such a dynamic environment requires businesses to develop sources of 'sustainable competitive advantage' to keep distance between them and rivals. A business may be wildly successful today, but absent a durable edge against competition, those gains are likely to be short-lived.

Stated differently, businesses need a moat in order to realize long-term success. In medieval times, castles would surround themselves with trenches of water called moats. The wider and deeper the moat--perhaps with extra obstacles like crocodiles tossed in--the greater the barrier against unwanted intruders.

In the context of business and markets, moats can take many forms. Proven, reputable brands. Valuable libraries of intellectual property such as patents, trademarks, copyrights. Great location for assets. Large economies of scale. Network effects from large, loyal customer/user bases. Unique capability for quick learning and adaptation. Hard-to-copy production techniques.

The best moats are unique and hard-to-copy. The larger and more impenetrable the moat, the more sustainable a business's competitive advantage.

Investors with long-term horizons need to develop skills at analyzing moats that surround businesses. What factors comprise a particular company's moat? Is the moat getting bigger, or is it shrinking? Stocks of companies with large and growing moats are more likely to appreciate over time. Stock dividends paid by these companies are likely to grow over time as well.

Stock research reports can sometimes offer valuable moat-related insights. In fact, research firm Morningstar (available thru Schwab accounts), conducts an explicit moat analysis for all companies that it follows. You might find useful.

If you are looking for stock investments to hold for many years, then accumulating skill at analyzing business moats is imperative.

References

Schempeter, J.A. (1942). Capitalism, socialism, and democracy. New York: Harper & Brothers.