How to Find a Moat in a Business?

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Introduction

We have very often heard about moat while doing a fundamental analysis of the company. In this blog, we will discuss various types of moats.

What is Moat?

This term was coined by Warren Buffet. Basically, a moat is a structure defending the insiders of the castle from any attacks by the enemies.

In terms of value investing, the moat is basically an entry barrier that provides a competitive advantage to a business, which helps in maintaining its market share and thus, profits for a longer run.

Types of Moats

Different Types of Moats

How to Find a Moat in a Business?

Let’s have a look at a few case studies.

1. Market Share
  • If a company has a market share > 50%, it is said to have a market share moat.
  • This is the market share that company has earned over the years and maintained because of different factors like product differentiation, marketing strategies, regulatory advantages, etc. This has helped the company in maintaining its profits.
  • Examples of companies having market share moat are as follows:
    • Pidilite Industries – Market share >79% in adhesives
    • Maruti Suzuki – Market share > 50% in passenger vehicles
    • Colgate – Market share > 55% in oral care business
    • Asian Paints – Market share > 60% in decorative paints segment
    • ITC – Market share > 80% in the tobacco business
  • Some companies like Asian Paints, Maruti, etc have gained a market share despite being a market leader in the current pandemic.
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2. Economies of scale
  • Large size companies have this kind of moat usually. Since they have a huge capacity, as the company increases its production, it achieves economies of scale.
  • Economies of scale are basically when a company’s variable costs decline with an increase in production. This helps the company in achieving operational efficiencies.
  • These operational efficiencies translate into greater profits eventually.
  • Companies also gain pricing power through this and cause other small scale companies to forcibly leave the sector.
  • Examples of companies having such moat are mainly from the manufacturing sector like steel, cement, etc.
3. Brand Equity
  • Strong brand value among the customers is also one of the moats for the company.
  • A well-built brand incorporates perception of the company’s premier and exclusive products and services.
  • This helps in customer retention even during difficult times due to customer trust.
  • This ensures that the profitability and cash flows of the company are growing at a healthy rate over the years.
  • Popular examples of companies having this kind of moats are Colgate, Dabur, Maruti, etc.

Also Watch: Moat Theory by Ramdeo Aggarwal

4. Patents/License
  • Patents and licenses allow companies to protect their production processes and charge premium prices.
  • This is translated into a sustainable source of cashflows and profits.
  • The company’s R&D capacities also impact the capability of the company to have this moat.
  • Examples of sectors where this kind of moat exists are chemical, pharma, Information Technology, etc.
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5. Deep Pocket Moat
  • Let us understand this with the example of Reliance Industries.
  • Currently, it has two subsidiaries – Reliance Jio and Reliance Retail.
  • The company entered into this segment by investing profits from its cash-cow business – Reliance Oil & Gas refining.
  • Thus, Reliance created deep pockets – Reliance Jio and Reliance Retail which helps the company in attracting lakhs of customers, take dominant pricing, acquire market share, etc.
Moat of Reliance Industries

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