Economic moat

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 –

  • Technology-based
  • People-based
  • Hard asset-based

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