Investors who have a little research on the investment strategy of Value Investing (Value Investing) should be familiar with the concept of "economic moat."。

"Looking for undervalued companies, buy and hold for the long term" is the concept of value investing, and if you want to find companies in the stock market that have potential, can make long-term stable profits, and are worthy of long-term investment, in addition to looking for clues from the company's financial reports, another key is the economic moat of the company.。

In 2018, at Tesla's quarterly call, Tesla founder Elon Musk publicly attacked the concept of moat as poor, arguing that companies should pay more attention to the pace of innovation。

What is an economic moat?？

The concept of the moat was put forward by Warren Buffett (Warren Buffett) in his annual letter to shareholders in 1993 - "Coca-Cola and Gillette Shaver have continued to increase their share of the global market in recent years due to their brand power, product attributes and sales channels, making them competitive, as if they had built a moat around the castle on the periphery of the economic castle.。"

Therefore, the economic moat means that enterprises have other competitors in the same industry is difficult to imitate or even surpass the competitive advantage, with a strong moat to stabilize the market position, so that enterprises can survive for a long time.。

So, what are the characteristics of the real moat of an enterprise?？

Pat Dorsey (Pat Dorsey), head of equity research at Morningstar (Morningstar), believes that the moat of a business can be divided into the following five types.

• Intangible Assets
• Switching Costs
• Network Effect
• Cost Advantage
• Effective Scale

Intangible assets

Intangible assets are assets that have no physical presence for business purposes, including brands, patents and regulatory franchises.。The value of many intangible assets depends on the benefits that can be created in the future, so assessing the value of an enterprise's intangible assets is like measuring its future prospects and competitiveness.。

• Brand

A good brand can have a place in the hearts of consumers, enhance consumer loyalty and trust, and are willing to pay a higher price to buy。

For example, Starbucks coffee is priced higher than the average small chain coffee shop, but it is still favored by most office workers and young people who are willing to pay for it; and as Apple phone users, most fruit fans will not give up buying because of the high price of Apple phones and choose to use other brands of phones.。

• Patent

Having a patent is tantamount to being protected by law, preventing other competitors from making similar products and excluding competitors in the same industry.。When a company wants to use the patented technology, it must obtain authorization from the patent owner.。

However, patents have a time limit.。When a patent expires, it is easy for competitors to legally use the patent。Therefore, enterprises must constantly innovate and invent new patented technologies or products in order to gain a firm foothold in the industry and maintain a competitive advantage.。

• Regulations Franchise

Some industries require government permission to operate, and there are relatively few competitors who want to enter the industry, so they have a strong moat.。

For example, waste disposal companies, refineries, water companies, sand and gravel farms and credit rating companies, as long as they obtain a franchise license, they can become exclusive market enterprises and enjoy a stable return on capital.。

Conversion cost

Conversion cost refers to the customer's high degree of adhesion to the product, has become accustomed to using a product, if you want to switch to using another product, will have to pay the cost, such as money, habit change, spend more time to re-learn, etc.。

Because it costs more to change an original habit, there is often a hassle, a reluctance to change and keep things as they are。

For example, a customer who usually uses an iPhone has become accustomed to the IOS operating system, and if he is now asked to switch to the Android system, he must take the time to get used to it and learn a new operating mode;。

Therefore, high switching costs mean that the product or service is closely integrated with the customer.。When it is difficult for customers to switch to other products or services, the business is prone to create a high degree of competitive advantage.。

network effect

When a company provides a service or product, as the number of users increases, through the introduction and sharing of the original user, connect more new users, so that the value of the company's service or product increases, forming a strong network effect, making it difficult for competitors to surpass。

For example, when more and more people around you use Facebook, it will unknowingly form a clustering effect, attracting more people around you to join in; another example is the early Instagram only provides photo filter function, users can share photos on Instagram, but also can share to Facebook, attracting more and more users to join Instagram, share their photos。

And credit card service providers (such as VISA, Master) will also because more and more stores can use these credit cards to spend, there will be more and more people to apply for such credit cards, the formation of competitors difficult to surpass the economic moat.。

Cost advantage

Price is usually an important basis for customers to decide whether to buy, so having a cost advantage is an important key。

If a company can have lower production costs than its competitors, it can naturally generate more profits, and the source of low cost may be due to its geographical location, special resources, low-cost production processes, or large economies of scale.。

For example, Walmart (Walmart), the world's largest retailer, has focused on saving money and reducing costs in purchasing, shipping, sales and inventory, creating its position as a retail giant.。A large number of purchases allow it to negotiate prices with bargaining chips, as well as with the increase in the number of stores and the establishment of logistics and distribution systems, but also to reduce costs.。

effective scale

In a limited market, only one or a few firms occupy the market, creating a monopoly-like phenomenon that can make it difficult for other competitors in the same industry who want to join to enter the market.。Because new entrants not only have to pay higher costs, but also have lower relative potential profits, resulting in lower overall returns。

Therefore, enterprises with effective scale have relatively few competitors.。Such industries are usually monopolies such as railways, telecommunications, utilities and airports.。

For example, the United Pacific Railroad (UNP), the largest rail network in the United States, operates in 23 states in the western and central United States and covers more than 31,900 miles of routes.。With an industry of this size, there are very few other competitors involved.。

Is the economic moat outdated?？

Economic moat enterprises are Buffett's principle in stock selection, such enterprises usually have a good and sustainable competitive advantage, so that enterprises can obtain long-term stable return on capital, and not easily replaced by competitors.。

However, Tesla founder Musk does not agree with the "moat" theory。He criticized the theory at the 2018 earnings conference as very staid and outdated, noting that if the only defense against the enemy is the moat, it won't last long.。The important thing is innovation, which is the core of maintaining competitiveness.。

Buffett, for his part, countered that he did not believe that technology had destroyed the moat of every industry and that there were still many strong moat companies in the market, noting that Musk, while achieving disruptive innovation in some areas, would not necessarily be able to surpass them in the confectionery industry (Buffett's Berkshire owns See's Candies, a well-known American confectionery brand).。

As you can see from the two men's ideas, Buffett is after a deterministic future and Musk is after an uncertain future。

Perhaps, it is still feasible to use the moat concept to select enterprises, but today's industries are changing rapidly, science and technology to promote industrial innovation, many industries have been subverted, and the birth of new economic models, such as the sharing economy, online shopping and online medical care.。Therefore, companies that want to maintain a long-term competitive advantage must continue to create new moats so that they are not easily eliminated.。After all, profitable business models are vulnerable to new competitors.。

How to distinguish true from false moat？

Firms with real moats are able to maintain a competitive advantage over the long term, making it difficult for other competitors to catch up。However, there are also some enterprises that appear to have moat characteristics, but in fact they are not necessarily reliable.。

Companies with quality products, high market share, and excellent management can easily feel that these conditions are in line with the characteristics of the moat, but this is often overlooked for the true nature of the moat。

Quality products or services and high market share companies may have an advantage in a short period of time。But if this market entry threshold is not high, it is easy to be imitated and copied by competitors in the same industry, leading to a decline in competitiveness.。And excellent management is not a sustainable advantage, management is prone to mobility, so full of uncertainty。