Add Economic Moats To Your Stock Analysis Protection offered by economic moats

Adding economic moats to your stock analysis can help you to develop and be confident in your investment thesis, i.e., why a stock is a good pick for your portfolio. A company’s economic moat can also shed light on loser stocks you have and don’t know what to do with.A moat is a ditch, either dry or filled with water, surrounding a castle or town, that acts as a primary line of defense. Historically, moats were used to protect our most precious asset: where we live.The term economic moat refers to the factors that help a company survive and thrive, and how long these factors will exist. In other words, what keeps the castle standing and for how long. Is the castle protected by a moat and structures that are wide and built to last, or is it without a moat, still standing only because the lord of the castle is a genius that no one wants to or can take down for now?Let’s dig in.Protection offered by economic moatsAn economic moat is a lasting competitive advantage that makes a company better than the others. A wide and durable economic moat helps a company ward off competition and makes it easier for it to generate above-average returns for years.What constitutes an economic moat for one company or industry differs from another. Morningstar identifies different types of protection that constitute economic moats:

Switching costs that make it too difficult or costly for customers to switch from one supplier to another. A company enjoying this type of protection is said to have a sticky business model.

A network effect that makes a product or service more valuable and appealing as more people use it. It’s a snowball effect; as more people buy the product, the company improves it, making existing customers happier and drawing in new customers. Rinse and repeat.

Intangible assets include patents, trademarks, brand recognition, and proprietary technology.

Cost advantages refer to the ability to produce goods or services more cheaply than the competition. Just think about Amazon or Walmart.

Efficient scale means that the market where a company operates limits the number of competitors, for example, regulated utilities that are granted a monopoly over a region.

A company can have more than one of these types of protection in its armor. Stay tuned. Articles in the next few weeks will explore these types of economic moats in detail.More By This Author:Buy List Stock For April 2024: Automatic Data Processing Know the Risks Of An Over-Diversified PortfolioExplaining The Brookfield Companies