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Analyzing Moats: The Factors I Consider
A company's moat, or its ability to prevent others from disrupting its market, is an important part of its ability to have success over the long term. When analyzing companies for investment, I pay careful attention to the moat.
I look at the following six factors:
- Network Effects - when each additional user adds value to the product, the company has a strong network effect. $ETSY is a great example. As more and more sellers bring unique products to Etsy's platform, more and more buyers are drawn in. As more buyers use the platform, more sellers are enticed to sell on it, and so on.
- Switching Costs - a company has high switching costs when users would face challenges or a significantly worse experience if they switched away from the company. $TWLO is a good example of this. Their software is very difficult and expensive to develop, and thus, any company choosing to develop the software on their own would incur high costs.
- Assets - assets that are important to consider include brand, patents, and government protection. For brand, think of $Z (Zillow), whose brand is googled more frequently than the term "real-estate." Speaking of which, $GOOG is another company with a great brand.
- Cost Advantage - a company with a strong cost advantage has a leg up over new entrants to the market (think scale, low-cost production, effective distribution, etc.). $AMZN is a clear example of this. Because of their extreme scale and effective distribution network, $AMZN is very difficult to disrupt.
- Counter-Positioning - when a company is counter-positioning, that means that its competitors would actually be harmed by adopting its business model. $TSLA, for example, does not use traditional car dealerships, but rather sells their cars online. Other car companies cannot simply cut their dealerships, at least without facing significant harm in the short term.
- Widening - finally, and simply, is the moat widening relative to the competition, or is it narrowing? For most quality, growing companies, the moat is widening relative to the competition.
What other moat factors do you all look at?
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