Yahoo Finance Investors Wade Into 'Wide Moats' for Long-Term Gains
"Wide moat investing": it sounds like a maneuver in "Game of Thrones," but it's actually a strategy of investing in companies with clearly defined, defensible, competitive advantages that are likely to last upwards of 20 years.
Legendary investor Warren Buffett coined the term years ago, but it has been propelled to the forefront of mutual fund managers' considerations, as wide-moat equities deliver consistent, strong returns on invested capital.
Elizabeth Collins, director of equity research, North America, for Morningstar, the Chicago-based fund research firm, says the concept is embedded in "100 percent" of Morningstar analysis. She'd know: She and co-author Heather Brilliant wrote the book on it: "Why Moats Matter," published in 2014.
Companies often claim competitive advantages but rarely describe them in terms of "moats" -- wide, narrow or nonexistent -- in corporate reports and filings. But for long-term investors, moats both insulate company operations from economic shocks and repel invaders, thus increasing the chances of steady, predictable, substantial returns.
The pace of change is increasing, but Collins is sticking with her definition of 20 years for a wide moat. "Things are happening more quickly today," she says. "The hurdle is that companies must be expected to achieve sustainable profits for at least 20 years. We're not changing the 20 years, but there might be fewer companies with wide moats."
A moat is literally a bulwark against corporate raids, embargo and assault. While all companies claim to have competitive advantages, many of those are fleeting -- think fast-fashion companies whose business models depend on teen fads and many tiers of suppliers in far-flung locations.
Commodity companies with few or weak differentiators, and that compete on price, have no moats protecting them from corporate Huns, according to analysts and fund managers. Likewise, companies with one or few products or services, which can easily be replicated, will have trouble fending off competitors.
But moats are made of more than patents, copyrights, brand loyalty and great products. The strongest moats have all those factors plus hidden advantages. The greater the cost or hassle to clients or customers of switching to a competing product, the wider the moat. The more protected patents, licenses, approvals and regulatory hurdles are to competing products, the wider the moat. The more expensive it is to replicate the infrastructure required to perform the service or produce the goods, the wider the moat.
Analysts point to Research in Motion, maker of the Blackberry smartphones, as a company that drained its own moat. It appeared to have all the qualifications of a wide moat: unique technology used daily by corporate types and celebrities. But Apple breached Research in Motion's moat with its iPhone, which was easier and more fun to use. Despite corporate resistance, iPhone devotees displaced Blackberry's ranks.
By way of contrast, analysts say, Allergan (AGN), the company that makes wrinkle-erasing Botox, has maintained a clear moat. So many licenses, approvals and tests protect Botox that it would be a formidable feat for a competitor to replicate it. Meanwhile, the Botox brand has become synonymous with quick, easy, in-office, quasi-medical cosmetic procedures. Few competitors have the resources or will to lay siege to that kind of brand awareness, not to mention practitioner loyalty.
Martin Wildy, a fund manager with Eventide Funds, based in Omaha, Nebraska, scrutinizes customer loyalty data and rankings by customers and employees to detect wide moats. "Customers and employees know what's really going on," he says. "Companies can't fake it."
While technology changes ever-more-quickly, some tech companies have engineered fearsome moats, Wildy says. He cites Adobe (ADBE), with its Acrobat document reader, and file-sharing company Dropbox as widely adopted platforms that are unlikely to be dislodged.
"Traditionally, people think that the moat is a brick-and-mortar asset," Wildy says. "But the clearest way to capture return on invested capital is through barriers to entry."
Aside from Morningstar ratings, don't expect companies or coverage to trumpet moat status, says Brandon Rakszawski, a manager with Van Eck Global, a New York investment management firm.
Morningstar offers three moat ratings: no moat, wide moat and narrow moat, the latter of which translates to more shallow or shorter-term competitive advantages.
And, yes, a moat can become a mirage. "It tends to be a big deal if you fall from wide to narrow or narrow to no moat," Rakszawski says. "When a company is downgraded, it's notable. "
Weight Watchers International (WTW) long enjoyed a pristine moat, as few weight-management systems approached its level of accountability, Rakszawski says. But that moat has been drained by digital companions such as FitBit and food-diary and calorie-tracking apps. Weight Watchers, he says, is now seen as a bit of an anachronism, and its investment grade has eroded accordingly.
"This is not a buy-sell type signal or rating. This is a long-term rating," Rakszawski says. "It's a very forward-looking assessment."
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