In earlier lessons of this series, we introduced the concept of an economic moat and the role it plays in identifying whether a business will stand the test of time. To define, an economic moat is a long-term competitive advantage that allows a company to earn oversized profits over time. Quite simply, companies with a wide moat will create value for themselves and their shareholders over the long haul, and these are the companies you should focus your attention on.
The term "moat" in regard to finance was coined by one of our favorite investors of all time, Warren Buffett, who realized that companies that reward investors over the long term most often have a durable competitive advantage. Assessing that advantage involves understanding what kind of defense, or competitive barrier, the company has been able to build for itself in its industry.
Moats are important from an investment perspective because any time a company develops a useful product or service, it isn't long before other firms try to capitalize on that opportunity by producing a similar--if not better--product. Basic economic theory says that in a perfectly competitive market, rivals will eventually eat up any excess profits earned by a successful business. In other words, competition makes it difficult for most firms to generate strong growth and profits over an extended period of time since any advantage is always at risk of imitation. The strength and sustainability of a company's economic moat will determine whether the firm will be able to prevent a competitor from taking business away or eroding its earnings.
How to Build a Moat >>