“A truly great business must have an enduring ‘moat' that protects excellent returns on invested capital” -Warren Buffett
My most successful and long-lasting investments have always come about when I've invested in a company with a strong and enduring “moat”. Buffett worked out long ago that a company that's able to sustain high returns over a multi-year period will generate outsized rewards for shareholders.
Many investors and analysts confuse a high ROIC with an economic moat. While a high ROIC can be an indicator of an economic moat, it's dangerous to equate the two because more often than not the high ROIC is a result of temporary factors. The nature of capitalism is such that high returns are rarely sustainable. Other companies will notice those returns and capital will immediately be attracted to that industry. If a business can earn a ROIC of 20%, why wouldn't I invest capital in that area? This brings in competition, prices are lowered, and over time ROIC will decline.
An economic moat is a wonderful thing because it allows a company to keep earning a high ROIC, unencumbered by competitive attacks. A high ROIC and strong growth are powerful bedfellows, allowing companies to grow earnings without investing excessive amounts of capital. While these situations are hugely valuable, they are also incredibly rare. In practice, what may look like a wide moat can easily be breached when subjected to a sustained attack from competitors. This is why it pays to be aware of the different types of moat and how they protect returns.
A Strong brand
Buffett is attracted to businesses with strong brands, like Coke (KO) or Gillette (PG). These businesses are able to charge more for their product than competitors because of the inherent value customers put on the brand. Great brands create a strong bond with customers, who trust the product will be high quality and associate it with something that goes beyond the value of the product itself. StockViews analyst Liam Garrity-Rokous recently wrote about Harley Davidson (HOG) in an article that I think does a great job of summing up the strength of the brand:
