How to Avoid these Mistaken Moats

If you have read our previous article on "How to invest in Quality Companies with Strong Economic Moats", you would see that economic moats help the companies to thrive for a long time and reward shareholders handsomely during the period.

However, as savvy investors, we also need to know and separate out the wheat from the chaff.

There are many seemingly great companies but with weak moats that give way easily to disruption.

Below, we highlight 2 such misconceptions which we should be aware of:

1. Great Products are not Equal to Great Moats

Remember Thumb-drives, CD’s, MP3s? All were great products but none of them lasted.

Similarly, Friendster/MySpace used to be the de facto social media platforms until Facebook came along.

Facebook also cannot rest on its laurels as TikTok is pushing boundaries with its video-first model.

Thus, unless a company can leverage its product to create a durable economic moat (which we cover 4 of them in our previous article), any promising returns will probably be disappear after a short time.

Due to technological advancement, only companies who can innovate will survive the next wave of disruption.

Here’s one exemplary quote from Tesla’s founder Elon Musk on his emphasis on innovation:

Failure is an option here. If things are not failing, you are not innovating.

2. Bigger is not necessarily Better

In highly competitive industries, a high market share is not equivalent to a competitive advantage.

Kodak (film), Netscape (internet browsers), and Borders (bookstores) were once HUGE companies but they failed to maintain their moat which led to either a demise or a sale.

Although a big size can help a company achieve better economics of scale, it can also incur high expenses and often have the red tape/huge inertia to pivot its business direction.

One classic local example is Singapore Press Holdings (‘SPH’ in short).

Despite being the monopoly media giant in Singapore, it is facing an ‘onslaught’ from global publishers where many people are reading off the juicy news from Facebook or other free content portals like Mothership.sg.

With that, the lucrative advertisement income which goes in line with the readership also took a hit and slowly withered off in just a few years. Things got off a twist where the media division is now spun off into a non-profitable organization, a far cry from the once-monopoly’s heydays.

Conclusion – Focus on the Moat’s Longevity

As you can see, investing is often both an art and science. Although financial numbers are important to assess the company’s current performance, investors still need to evaluate from a qualitative angle and see whether a business will stand the test of time.

Another note is that economic moats are generally difficult to pinpoint at the time they are being created. Their effects are much more easily observed in hindsight once a company has risen to great heights.

It is also ideal for investors to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat. In this case, the most important factor is the longevity of the moat. The longer a company can harvest profits, the greater the benefits for itself and its shareholders.

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