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