Here are some metrics to see if the firm has an economic moat –
- Has the firm been able to generate consistent RoA
- if so, why? is it regulation, or true competitiveness?
- is it greater than 6-7%?
- What is the competitive advantage period?
- If FCF/sales is consistently >5%, we may have found a cash machine, and this is a good sign of a moat
- Is RoE > 15%?
Then we need to understand where the moat is coming from, which will help us understand if it will stay
- Real product differentiation (usually gets eaten away)
- Perceived product differentiation
- Lower costs (needed in a commodity business)
- High switching costs (increases over time, unless in time of paradigm shifts)
- Locking out competitors by legal or regulatory reasons
Another way to categorize the economic moat may be –
- Hard asset-based