Stocks with wide moat are companies that have “something” that keeps competitors at bay and allows the business to earn supernormal profits. The term came about from the water-filled moats that surrounded castles of the Middle Ages (like the photo above). The wider the moat, the harder it would be for an adversary to penetrate the castle. Some of the examples of companies with wide moat would include Coca-Cola, Wrigley and Walmart.
Having a wide moat allows companies to have excessive earnings and this eventually causes the share price to rise. However, not all companies with wide moat actually lasts. This may sound shocking but this has become more evident recently. Think of Eastman Kodak, Britannica Encyclopedia, newspaper companies and physical bookstores. Kodak filed for bankruptcy in January 2012. Who would have thought 30 years ago that Kodak would go bust? Kodak was one of the strongest brands in the world and anyone who had used a film camera would have used Kodak’s films (the ones that came in the prominent yellow boxes).
Another company to file for bankruptcy was Borders in February 2011. Even though Borders might not have had the status of being a wide moat company, it also fell into the depths of Chapter 11, just like Kodak. Britannica Encyclopedia is now obsolete too. Who would pay thousands of dollars for an encyclopedia now when information on the internet can be obtained for free (if you do not mind the inaccuracy at times)? Newspaper companies are struggling nowadays as well.
I remember using Kodak’s films and Britannica Encyclopedia when I was in primary school. I also remember visiting Borders bookstore at Wheelock Place frequently when it was still around. Now, they have all been wiped off due to the advent of something massive – technology. Rarely anyone carries analog cameras nowadays. I don’t think anyone still uses Britannica Encyclopedia as it is no longer in print. Books are now read on a tablet by quite a lot of people (not me, I still prefer physical books). Many go online for their daily dose of news. Technology is changing many aspects of our lives. However, technology cannot change how we chew gum, how we consume chocolates and drinks. Companies with wide moat such as Coca-Cola, Wrigley and Hershey’s will not go obsolete like Kodak.
When analysing companies before purchasing, we have to look if technology can make the company we are about to invest in obsolete. After purchasing the company, we still have to monitor it by looking at the net profit margins and returns on equity (ROE) every year. We have to ensure they are consistent and preferably rising and not dipping year after year. If the margins and ROE are coming down significantly, we know that the competitive advantage is being eroded and we have to look further to determine why this is so.
In conclusion, buying companies with a wide moat without determining if the moat is durable, is disastrous. Technology can rapidly change the economics of a business. We have to always ensure that technology will not destroy the wide moat of the business we are investing in.