Sustainable competitive advantage (or an economic moat) is a company’s ability to maintain or grow their earnings and protect their market share from competitors over time. Warren Buffett famously shifted his investing style from a focus on finding firms severely undervalued to one focused on investing in quality firms that can sustain their earnings level far into the future.
I believe an important skill that needs to be developed and improved is the ability to successfully identify firms that have a sustainable competitive advantage and are therefore likely to be sound long-term investments. I think it is possible to set up an exercise that would allow an investor to improve their accuracy in this area. To be effective the practice would need to break down into two key components:
- Evaluating whether a company has an economic moat
- Feedback on whether companies identified maintained their advantage
Economic Moat – Exercise
- Pick a year to evaluate (5-10 years ago).
- Based on set criteria, evaluate whether the target company had a sustainable competitive advantage in that year.
- Compare the results from step 2 to the company’s performance over the following 5 years – was the conclusion in step 2 accurate?
- If incorrect, try to identify any mistakes made or find any external factors that may have changed the outcome.
I plan to use the exercise above as a way to improve my ability to identify companies with a sustainable competitive. The form of the practice will undoubtedly be revised (and hopefully improved) but I believe this is a good starting point and meets the basic requirements of deliberate practice that should result in a steady improvement in my abilities.