Economic Moat: If I ask you what is the moat? Only a few of you can answer this question. Moat is how unique the company is? If you get to know how unique the company is, will help in time you to buy good profitable stocks in the stock market. You need success in your job, then the moat can create your value as well. The concept of the moat is wonderful for both companies and an individual.
If you search this word “moat” in a dictionary, you get the moat definition as,
“a deep, wide ditch surrounding a castle, fort, or town, typically filled with water and intended as a defense against attack.”
In the stock market, people find difficulty in which tock to buy or not. The moat concept gives you an answer.
As its meaning is given clearly in the dictionary that moat is a deep and wide ditch surrounding a castle. In an Ancient world, the castle was protected with a deep wide moat filled with water. Moat helps the castle to protect themselves from outside attackers. The wider and deeper the moat is, the more protected the castle is.
Similarly, the companies are protected from competitors with their unique products and monopoly.
Here, the castle is the company any which safeguards from the attackers. The attackers are the company’s competitors and the Castle safeguard from the attacker with a moat. The moat is the company’s unique products and monopoly.
The below infographic can give you a clear picture.
WHAT IS ECONOMIC MOAT?
The concept of Economic Moat was suggested by Warren Buffet. In Economic Moat, the company has a competitive advantage over competitors. The advantage in terms of the market share and the profit. To build market share and a good percentage of profit, it took years for a company.
So, to protect them, good companies build a moat around.
LET US IDENTIFY MOAT STOCKS
ROCE & MARKET CAPITALIZATION
To identify the moat stocks for investing, first, you must identify the company ROCE. ROCE stands for RETURN ON CAPITAL EMPLOYED. ROCE can be seen in the company’s financial statements.
Why you must look at ROCE, is because as per Economic Moat, it tells you about the profitability of the company.
Market capitalization is the main consideration in Economic Moat. To know about market capitalization read Stock Quote Part-2.
The combination of Market Cap and Profitability tells you about the moat of the company.
For example: Suppose there are two different companies, Company-A and Company-B.
Company-A has a market cap of approx. 2,16,868 Cr. and ROCE value is 1.94%.
Company-B has a market cap of approx. 7,72,275 Cr. and ROCE value is 3.43%.
Both companies belong to the same sector. With these two values, you can conclude the moat between them.
The company-B is more profitable and has large market capital than company-A. That gives a clear picture that company-B has a wider economic moat than company-A.
The ROCE is self-explanatory. It means the return on capital employed. How much profit the company gets on its cost of doing business. The higher the profit, the higher will be ROCE.
The other profitability factor under Economic Moat is ROE. ROE stands for Return on Equity concerning the stockholder’s equity. It measures the profitability of the company along with ROCE.
For the selection of good economic moat stock, always consider a higher ROE company.
Higher ROE is one good indicator. For the selection of Economic Moat stocks, check higher ROE companies in the same sector. Also, find the company ROE is increasing in the last 5years continuously.
For selecting the Economic Moat Stocks; the company whose ROE is higher than the last 5years Avg. ROE is the best practice for selection.
HOW TO FIND DATA FOR ECONOMIC MOAT STOCKS
ROE 5Y AVG. (%)
ROE SECTOR (%)
The above table gives a clear picture of two different sectors (Energy and Banking Sector) companies.
ADVANTAGE OF ECONOMIC MOAT
- With a good Economic Moat, the company will have little or no competition.
- The companies will have a distinct cost advantage.
- Companies enjoy pricing power.
- Companies generate large profits.
- The company generates a monopoly in the market that produces more other benefits.
- Economic moat increases companies Brand Value.
- Branding, patents, and trademarks make it hard for others to copy and to compete.
To overcome the selection difficulty in the stock market, the investor must look at the Economic Moat for the company. A good profitable company can only be found by research, studying financial statements of last 5years thoroughly. The self-study can conclude the best stocks for investment.
Only these factors are not the only factor for the selection of the stocks. There are many more studies to find good stocks for investing. But finding the good moat stocks can cut your long list short and make you easy for the proceedings.
Beyond the financial reports, it is also advisable to observe the overall market in general. I hope this small but important concept helps you to find your pick and gain in the long term.
“Look for durability of the franchise. The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.” – Warren Buffet.