I'm been wanting to write this for a long time.

Because it's probably the most important thing to understand when analyzing a growth company.

What is their unfair (but legal) advantage over their competition?

Also known as an economic moat

THREAD

The concept of the economic moat was popularized by Warren Buffett and Charlie Munger.

They preferred investing in companies that had some sort of unfair (but legal) advantage in the way they ran their business.

$KO has an unfair advantage by having a globally recognized brand name.

See’s Candies, a highly publicized Berkshire Hathaway investment, has a strong brand name as well.

So does GEICO and other companies that they've invested in over the years.

But a good brand isn't the only way to achieve a moat

Moats comes in many forms

Walmart’s $WMT moat is the high economies of scale it achieves, enabling it to slash prices to levels that are unsustainable for smaller competitors.

A local store cannot buy inventory in the volumes that Walmart does and cannot reduce prices to that extent.

This naturally eliminates competition. Amazon enjoys similar advantages in the online retail space.

Google and Facebook enjoy another type of moat, which is increasingly relevant in the digital business era.

The network effect.

The more that people use a company’s product

The better the product becomes.

For example, Google’s search algorithm was extremely rudimentary when it debuted.

However, as more people used Google...

The more data it could collect...

The more its algorithm learned human speech patterns and search tendencies...

For companies like Google, more users equal greater profits.

Similarly, Facebook derives most of its market value from its large user base.

The more that users stay on the platform...

The greater the quantity of data that Facebook collects...

This insight allows Facebook to provide better targeting services for advertisers, which fuels ad spend on the platform.

For example, a Facebook advertiser can elect to show their ads only to female small business owners aged between 35-44, who live in Los Angeles.

When you compare that level of specificity to TV or print advertising...

It’s easy to see why total advertising spend on Facebook has increased by 400% over the past five years.

The network effect is tough for competitors to overcome since they cannot merely improve on an existing product.

They need to reinvent the entire business model.

Businesses that have economic moats survive tough times better than ones that don’t.

The opposite of a company that has a moat is one that sells a commodity product.

A commodity product is one that differentiates itself solely on its price.

For example, if you were in the market for a new mouse for your laptop, you’re going to choose one that is ergonomic and effective but only up to a certain price.

Another example is the pen you choose to write with.

On the face of it, Walmart has a commodity product.

The only reason people shop there is that they offer the cheapest goods.

However, there’s a difference between selling products that are differentiated solely on price versus what Walmart does.

Walmart consistently delivers the cheapest goods, no matter the broader economic conditions.

There is no other business in America that can do this as efficiently as Walmart does.

Thus, the moat it has doesn’t have to do with price.

It’s more about how Walmart conducts its processes that ensure it can offer the lowest price all the time.

Other examples of moats are companies operating in non-sexy industries.

Unattractive industries are great because companies receive less analyst attention

They are less prone to disruption, and the incumbents can often have a natural monopoly.

A great example of this is Waste Management $WM

You don't have to be a genius to figure out which industry the company is in.

Now imagine being an employee of Waste Management.

If you met someone at a barbecue, would you introduce yourself as your job title "I work in marketing,"

Or would you let them know you work for a company called Waste Management?

In addition, there aren't too many 20somethings in Silicon Valley spending all night hyped up on caffeine and Adderall

Hypothesizing on how to disrupt the waste management industry.

That is a big reason why the stock is up 400% in the past decade while simultaneously increasing its dividend payouts.

Another factor that can cause a moat is a company operating in a morally or ethically dubious industry.

Tobacco $MO (up 1,000% in the past 20 years)

Alcohol $STZ

Casino companies $LVS

All fall under this category.

Many analysts and investors stay away from these so-called "sin stocks"

Making their valuations more appealing

Patents are another form of moat.

A lot of Twitter users love $ABBV - and for good reason. Their patent on Humira allows them to bring $20 Billion worth of revenue in every single year.

Note: That patent expires in 2023, so it's worth taking into account.

Another Twitter favorite $DMTK has a solid patent moat

$DMTK has a patent on their new PLA procedure until 2030

Meaning a competitor can't just come in and duplicate the procedure while charging less.

The beauty of long term investing is that you can eliminate pretty much any industry you don't want to invest in but still make a killing in sectors that do fit within your views or beliefs.

But whatever your industry, and whatever the company.

Make sure it has a moat

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