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Identifying Moats Like Warren Buffett (Part 1)
Education | 11 February 2015
By: Louis Kent Lee
Articles (199) Profile

The legend behind value investing is well-known for identifying great companies from mediocre ones.

This, is done through the identification of moats when you analyse companies.

A moat is essentially something that endorses a value standpoint of a company that is so strong, that you don’t have to worry about it not being able to generate economic returns for the forseeable future.

This something is also essentially a deterrence from competitors to copy, emulate and unintentionally creates a barrier to competiton from other companies.

There are basically a heavy fistful of moats that we look at day in day out at Shares Investment whenever stocks are discussed in the office, pantries, and even over drinks.

Let’s kick this moat-tion (pun intended) off with the first one that we see around us, but not able to touch physically.

The Power Of Brands As A Moat

A brand is a powerful intangible asset if it creates the effect of continued recognition, in the form of repeat customers, and even warrant a certain range of pricing for the company’s products.

It is even more powerful, if it’s weaved into a habitual behaviour.

A classic example would be Coca Cola, where the merits of the product creates consumer loyalty.

Coca Cola essentially makes you more thirsty than before you drank it.

However, it is the ability of it to couple a brand association to a certain image and perceived value of its brand, and create lasting repeat customer purchases.

Coca Cola easily competes with more than a dozen cheaper, generic equivalents out there in the market, but still manages to charge 20 – 30 percent more than such brands.

Why is that? That’s because consumers identify with the value that they associate Coca Cola with, and continues to purchase their favourite brand.

When A Brand Does Not Add Value; No Moat To Talk About

Just to be clear, a brand, by itself, does not confer competitive advantages of any sort.

Brands only create a value if they increase the willingness of a customer to pay for that particular product.

Essentially, Brands only add value and can be seen as a moat if it stems the willingness of consumers to pay for a brand in the habit of using the product, have an emotional connection (perceived association) to it, or believes that it confers a certain level of social status.

SI Takeaway

It is quite easy to identify a brand.

The tougher part is when you are looking at a company with this trait, you’ve got to ask yourself the question if it warrants a real classification of a moat, like what was discussed above.

We will be talking about the moat related to specific licenses and patents in the next tutorial.

Louis is a qualified accountant with the ACCA, and is the Research Editor at Shares Investment magazine.

Please click here for more information about this author.

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