When it comes to long-term investing, you want to look for an entity that has a durable competitive advantage (moat). A business that is not only doing well now, but will do well 10,20,30 years from now.
A business with strong long-term economics will tend to inherit some form of a competitive advantage. If this advantage is durable, then the underlying value of the business will continue to increase overtime and so will your investment in the business. (Assuming you brought in at a fair price.)
Types of Competitive advantage
Generally, there are three main economic models a wonderful business can have in its favour to serve as a durable competitive advantage.
1. The low cost producer
Being the low cost producer is arguably the most formidable competitive advantage a wonderful business can have. The low cost producer will usually have the highest profit margins.
The Coca-Cola company (NYSE:KO) has a 10 year average Gross margin of 62%, operating margin 22% and Net margin 20%. A business with consistently high profit margins can benefit from either being able to offer higher prices for its products/services or from obtaining low cost supplies and economies of scale. Such high margins has allowed Coca-Cola to dominate the soft drinks industry for decades and will continue to do so.
2. Strong Intangible Assets
Walt Disney (NYSE:DIS) dominates the diversified media industry, primarily due to its inherent competitive advantage arisen from its intangible assets. It is crucial to note, that we are not referring to the figure that is reported on the company’s balance Sheet, however the actual underlying intangible assets themselves. Disney’s global brand name and share of mind power (ability to get inside the minds of customers to encourage trustworthiness around the brand), along with the inherent positive cultures contributes to the company’s ability to consistently withstand new entrances, whilst maintaining customer loyalty on a global scale.
3. High Switching costs (Stickiness)
Microsoft (NASDAQ: MSFT ) is a very unique company, despite popular belief. Microsoft not only has been able to develop a strong durable moat, however it has done so in a highly competitive, innovative and fast paced technology industry. Microsoft benefits from having high switching costs, which forces existing consumers to stick with the company’s products/services despite of intense competition.
The design and function of the Microsoft Office package which can be used on a variety of PC’s and laptops, truly promotes this advantage. As it would be difficult for consumers who have been bread using the Microsoft system to switch to a substitute package. This is because it would require; higher costs to switch to new products, learning of the substitutes system and plenty of time to integrate the new system into a organisation. Henceforth, Microsoft now operates like super glue, as it sticks consumers to the business for long periods.
* There are many other potential competitive advantages a business can obtain. The key is to identify the most formidable ones and assess there long term durability.