The most successful companies in history don’t just have legendary profits. Generally, they build a substantial lead over their competitors, known as an economic moat. This scenario gives rise to wide-moat stock, a type of sustainable competitive advantage a business possesses. A wide-moat stock is a share of that type of business. Here’s what it means.
If you need help picking an investing strategy, a financial advisor can help.
What Is a Wide-Moat Stock?
A wide-moat stock is a share in a company that dominates the market through a superior product, business strategy or brand. The company’s staying power among its competitors makes it a reliable investment. Therefore, it’s known as wide-moat stock because just like a moat would protect a medieval fortification, the company’s stellar track record and excellent reputation protect its stock from declining in value.
A wide-moat stock can maintain its staying power with a patent or multiple patents, which makes it hard for other rivals to try and duplicate. Such a status would also not only make it hard but possibly discourage those from starting a business and entering a particular industry. This would create long-term profits for a wide-moat stock.
Economic moats might only exist for a short time. Investors typically use the term ‘narrow moat’ to describe economic moats that will persist for about a decade. On the other hand, ‘wide moats’ generally endure for two decades or more. Remember, various factors, including competitor activity, intellectual property and customer loyalty, can affect how wide a moat is.
Sources of Economic Moats
Economic moats arise from numerous factors:
- Network effect. In other words, companies usually thrive as more people engage with their products. For example, Amazon performs better when more users buy and sell goods on the platform.
- Cost advantage. Companies that can reduce prices for their customers can outperform more expensive competitors. For instance, Walmart’s consistently low price tags have given the company a crucial edge for decades.
- Intangible assets. Brand name and customer loyalty aren’t measurable in a material sense, but a famous company can build economic moats through reputation.
- Minimum efficient scale. Breaking into a new market is challenging. Generally, pre-existing companies can spend less money to advertise and sell products than a company launching in a crowded market.
- Sunk cost difficulties. Companies occasionally overcommit to a specific strategy. For example, they might allocate undue resources to unproductive partnerships. On the other hand, companies that stay flexible enough to pivot to a new, less costly approach can outdo their competitors.
How to Identify Wide-Moat Stocks
While it’s easy to identify a successful business in hindsight, investing in wide-moat companies requires analysis of current trends in the market. Follow these tips to identify wide-moat stocks that can bring robust future gains:
Enduring Market Volatility
Nothing signifies success like thriving during a bear market. Wide-moat companies reveal themselves by maintaining a solid performance and not folding under pressure during adversity.
Healthy Cash Supply
Companies with cash on hand have the flexibility and resources to address problems that arise. On the other hand, it’s fair to say putting money back into the business or distributing dividends to shareholders are wise moves. However, consistently high, stable stock prices and huge profits indicate a company that may succeed for years.
Unique Intellectual Property
Companies whose intellectual property keeps competitors from developing similar products generally enjoy high profitability and market share. For instance, the pharmaceutical company has sold Humira for the last 10 years. Wildly successful as a medication for arthritis, it has flourished while intellectual property law prohibited other drug companies from making similar products.
Companies can become so successful that they’re a fixture in the average American’s life. For example, Kleenex is interchangeable with the word “tissue,” indicating its nearly 100-year run as the facial tissue product across the country.
Profit Differential From Competition
A company that pulls in significantly more money than its competitors can develop a wide moat. Plus, consistently stronger profits demonstrate the company’s ability to outcompete similar businesses.
Success With One Product
Companies with a single outstanding product can become wide-moat investments. For example, Zoom is the most popular video call platform focused on providing the best virtual meetings and calls. More customers use Zoom than any other video chat service, and the company pours most of its resources into optimizing this aspect.
Example a of Wide-Moat Stock
Nike has developed a wide economic moat in its industry in the last decade. Back in 2010, its stock traded for about $16 per share. However, it secured a greater market share by developing its online retail activity and fostering vital relationships with the NFL and NBA.
As a result, Nike created a renowned brand and now trades at over $100 per share. Plus, Nike’s success shielded the company from the worst of the COVID-19 crisis, allowing it to overcome economic hardship and quickly recover share value. So, investing in the company is profitable because of its wide moat. For instance, if you had bought $500 of Nike stock in 2010, it would be worth over $3,000 – a return of over 600%.
How to Invest in Wide-Moat Stocks
If you’re interested in wide-moat stocks, you can invest in them in the following ways:
- You can research and invest in companies you believe to have a wide moat. This approach requires time and effort to do your homework and consider numerous market variables.
- You can create an investment account with a firm that focuses on seeking wide-moat opportunities. While you won’t have control over which companies you buy stock in, the company can usually purchase shares at a reduced price and jump on emerging opportunities.
- Buy shares in an exchange-traded fund (ETF) that invests in wide-moat stocks. These funds have low expense ratios, with VanEck Morningstar Wide Moat ETF being the most popular.
Wide-moat stocks come from companies that drastically outcompete others in the market, rake in profits and maintain valuable share prices. As a result, finding these investment opportunities can strengthen your portfolio. However, it’s wise to understand the circumstances that give rise to wide-moat stocks, like intellectual property and new competition, as they can change stock prices over time.
Wide-Moat Stock Tips
- Wide-moat stocks can be challenging to identify, especially if you’re new to investing. That’s where a financial advisor can help. Finding a vetted financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Like wide-moat stocks, growth stocks usually provide excellent returns for portfolios. These assets come from rapidly growing companies. Use our guide to learn how to invest in growth stocks.
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