In 2016, you could buy a 1.08-carat diamond mounted in a platinum band for about $8,948 at Blue Nile.

At Tiffany, the same ring would cost you $13,900.

That’s $4,952 more… just to have it in a Tiffany Blue Box.

It shows you the power of a brand. It’s Tiffany’s “moat.” Competitors can sell the same diamond, but they can’t put it in a Tiffany Blue Box.

Tiffany has a moat. Blue Nile doesn’t.

So what’s a moat? We’ll explain in today’s essay…

Moats Keep Competitors out

A moat is what protects your business from its competitors. It allows you to do things your competitors can’t do – like charge $4,952 for a blue box.

It’s also the engine behind some the stock market’s biggest winners.

See Starbucks. When it began back in the 1970s, a cup of coffee was about 50 cents. Starbucks got people to pay a couple of dollars for their coffee by playing up the coffee’s quality.

It also brought McDonald’s-like quality control to coffee to ensure a cup of Starbucks coffee tasted the same everywhere. This was a big innovation at the time. And it’s made the Starbucks brand the powerhouse it is today.

Coca-Cola, one of the world’s greatest brands, is another example of a company with a wide moat.

Coke went public in 1919. Let’s say you were an investor in 1919, and a man from the future gave you a glimpse of what lay ahead: the depression of 1920-1921.

Then another depression – one that would go on for so long, people would forever call it “The Great Depression.”

Wars. Sugar rations. Inflation.

You probably would’ve guessed there were hard years ahead for Coke.

Yet if you’d bought $10,000 of Coke stock in 1985 when it was trading for just $1.50 a share and reinvested the dividends, it’d be worth $1.2 million today.

Pat Dorsey, the former director of equity research at Morningstar and former president of Sanibel Captiva Investment Advisers, uses this analogy to describe moats:

It’s common sense to pay more for something that is more durable. From kitchen appliances to cars to houses, items that last longer are typically able to command higher prices… The same concept applies in the stock market.

Moats make companies durable by keeping competitors out.

Five Traits of Wide Moat Companies

So how do you recognize a company with a moat? Here are five examples:

  • You have a strong brand.

Tiffany has a moat, as we saw. People pay up just to get that blue box, even though what’s in the box might cost less somewhere else. Starbucks is a great brand. It inspires loyalty and ensures recurring customers. That’s a moat.

  • It costs a lot to switch.

Banks have this kind of moat. There isn’t much of a competitive advantage that one bank can have over any other. They all have the same products. And with the internet, branch locations aren’t important.

Yet when you look at the numbers, people tend to stay at their banks for six to seven years. That’s because it’s a pain in the neck to change banks. As economists say, “switching costs” are high. That’s a moat.

  • You enjoy network effects.

Microsoft had a great networking moat for years. Everybody else used its operating system… So you wanted to, too. The more people used Microsoft’s operating system, the more it enjoyed network effects.

There are lots of network moats today. Think of Facebook, X (formerly Twitter), or YouTube. It’s very hard for competitors to replicate these businesses… to crack the network moat. It’s like trying to sell the first telephone.

  • You do something cheaper than everybody else.

If you’re the low-cost guy, like Walmart, you have a moat. Walmart destroyed many higher-priced retailers.

Interactive Brokers is another example. Its prices are much lower than every other discount broker. That partly explains why it’s growing twice as fast as its competitors.

  • You’re the biggest.

Absolute bigness can be an advantage if it keeps competitors out. Imagine what it would take to try to replicate the research capabilities of Intel or the purchasing power of Walmart.

Relative size can also be a moat. If you’re the dominant insurer of small taxi fleets, as Atlas Financial is, then you have a moat. Competitors are unlikely to invest the time and energy necessary to compete in a niche market.

This isn’t meant to be an exhaustive look at moats. There are other subtle ways a company could create a barrier other companies have trouble breaking through.

If you want to invest for the long term, make sure to find companies with wide moats. Those that have them usually get them from some competitive advantage. And these advantages don’t tend to disappear overnight.

Palm Beach Research Group