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The Concept Of Economic Moat In Evaluating Stocks

23 December 2021
4 minutes

As an investor, what are the parameters you set while making investment decisions? Selecting stocks with consistent cash flow or brands with robust operating efficiencies is a good strategy. Still, there are some uncertainties associated with stock investment. So what can you do? According to Warren Buffet, investments should be made in stocks with a wide economic moat.

The economic moat in the context of stock investment is something that provides a competitive advantage. The ‘moat’ indicates an edge a company has over its market competitors. A ‘moat’ separates it from its competitors. The pricing power of the company secures it from competition over a long period of time.

Tips to Identify Company with Economic Moat

Now that we are clear with the meaning of economic moat, let’s get started with how you can identify companies with an economic moat: 

  • Outstanding Performance Even in Slow Economy

Most businesses fail to perform when the economy slows down. But even when the economy is slow, companies with an economic moat perform well. The performance of the company will be better than its competitors. Some companies with an economic moat have even performed well even during the ongoing pandemic.

  • Increased Market Size

Companies having robust economic moats always stay ahead of their competitors. Their revenues and profits keep on increasing despite the condition of the economy. These companies stay ahead of any type of competition.

Why Is it Essential to Understand Economic Moat Before Making Investments?

If you are a valued investor, the best thing for you is to invest in a wide moat stock at underpriced value. Before making investment decisions, it is important to identify companies with an economic moat. You must check the following points in the financial reports to discover the economic moat:

  • Overall Sales Growth
  • Growth in Revenue and Profit
  • Profitability Enhancement that is ROE and RoCE
  • Besides the financial report, it is suggested that you check the overall market sentiment in total.
  • Check on brands gaining a reputation in the market because of their quality products and services.
  • Companies with a good market reputation and profits are highly reliable.

Note: Start your joy ride in the world of investment by identifying economic moat companies and making a long term investment.

Takeaways

  • If you are investing for the long term, choose companies with an economic moat.
  • This indicates long-term profitability. 
  • Financial reports of companies must be followed regularly to know the market condition of the company at all times.
  • Beyond the financial reports, it is also important to observe the overall brand reputation of the company in general.

FAQs

  • How Companies Build an Economic Moat?

Companies create an economic moat in the following ways: 

  • Decreased Production Cost: Companies need to follow the law of competitive advantage and produce cheaper products. They can do this by outsourcing the work that will be less costly.
  • Increased Awareness on Customer Switching: The marketing team should work in an actionable way and check on the reasons if a customer switches to other brands. Companies should work on the insight provided by the marketing team to stay ahead in the market.
  • Get Hold on Intangible Assets: Companies should ensure that they have got their Intellectual Property Rights in place, whether in the form of a trademark or patents. These will ensure that others can not replicate their products or services. It will help the companies to maintain sustainability in the market.
  • Create a Brand Value: With brand value, a company can generate more revenue and earn more profit in the market because the brand is recognised in the market. This concept is based on the concept that there is a well-known correlation between quality products and reputed brands. Companies with commodified products need to maintain brand value in the market.
  • What is the Importance of Economic Moat?

Economic moat ensures the long-term profitability of the company. Before investing in stocks of companies, investors need to look at economic moats. Warren Buffet says that a company with an economic moat can sustain itself in the market regardless of the market condition. Companies get a competitive advantage with an economic moat. With an economic moat, companies have got long-term sustainability in the market.

  • How to Spot Moat Companies?

Investors research a lot to identify moat companies. 

  • The main screening criteria is constant profitability and size of the company.
  • Most companies use ROE and RoCe numbers in their financial reports to show the profitability of the company.
  • The size of the company also matters in terms of market capitalisation and sales revenue.

Happy and Smart Investing!

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