- 1An economic moat is a structural competitive advantage that protects profits over time
- 2Five moat sources: network effects, switching costs, intangible assets, cost advantages, and efficient scale
- 3Moat companies earn persistently higher returns on capital
- 4Our profitability factor naturally identifies companies with strong moats
#What Is an Economic Moat?
Warren Buffett popularized the concept of an "economic moat" — a metaphor for the competitive advantages that protect a company's profits, like a moat protects a castle.
A company with a wide moat can: - Charge premium prices without losing customers - Maintain high profit margins over decades - Fend off new competitors and industry disruption - Compound shareholder wealth at above-average rates
#The Five Sources of Moat
1. Network Effects
A product or service becomes more valuable as more people use it.
Examples: Visa (merchant and cardholder network), Meta (social network), Microsoft Office (document compatibility)
Why it works: Once a network reaches critical mass, switching to a competitor means losing access to the network — a massive cost most users will not pay.
2. Switching Costs
The cost, effort, or risk of switching to a competitor is so high that customers stay even when alternatives exist.
Examples: Oracle (enterprise database migration), Apple (iOS ecosystem), Bloomberg Terminal (trader workflows)
Why it works: Customers are locked in through training, data migration costs, integration dependencies, and habit.
3. Intangible Assets
Brands, patents, regulatory licenses, and proprietary data that competitors cannot replicate.
Examples: Coca-Cola (brand), Pfizer (drug patents), Moody's (credit rating franchise)
Why it works: These assets take decades or billions of dollars to build and cannot be reverse-engineered.
4. Cost Advantages
Structural ability to produce goods or services at lower cost than competitors.
Examples: Walmart (supply chain scale), TSMC (semiconductor manufacturing expertise), Costco (membership model + scale)
Why it works: Low-cost producers can always undercut competitors on price while maintaining margins.
5. Efficient Scale
Serving a market that naturally supports only one or a few competitors due to limited demand.
Examples: Railroads (infrastructure duopoly), waste management (regional density), utilities (regulated monopolies)
Why it works: The economics of the market make it unprofitable for new entrants to compete.
#Moat Width: Wide vs. Narrow
| Moat Width | Characteristics | Expected Duration |
|---|---|---|
| Wide Moat | Multiple moat sources, dominant market position | 20+ years of excess returns |
| Narrow Moat | One moat source or weaker competitive position | 10-20 years of excess returns |
| No Moat | Commodity business, intense competition | Normal or below-normal returns |
#How to Identify Moats Quantitatively
Our factor model does not explicitly measure "moat," but moat characteristics show up in our quantitative metrics:
| Moat Signal | Our Factor |
|---|---|
| Persistently high margins | Profitability factor |
| Pricing power (above-average ROE) | Profitability factor |
| Stable earnings | Stability factor |
| Conservative capital needs | Investment factor |
| Market confidence | Momentum factor |
Companies that score in the top quintile on profitability for multiple consecutive periods almost certainly have an economic moat protecting their earnings.
#Moat Erosion Warning Signs
Even wide moats can narrow over time. Watch for:
- 1Declining margins — Competitors are gaining ground
- 2Rising capex without revenue growth — The moat is getting more expensive to maintain
- 3Customer concentration changes — Revenue from top clients shifting
- 4Technology disruption — New approaches undermining old advantages
- 5Regulatory changes — Government action removing competitive protection
#The Bottom Line
Economic moats are the foundation of long-term wealth creation. Companies with durable competitive advantages compound shareholder value at rates that far exceed the market average.
Our quantitative model implicitly identifies moat companies through the profitability and stability factors — companies that maintain high returns on capital for extended periods almost always have structural competitive advantages.
Last updated: February 10, 2026