Legendary investor Warren Buffett is well-known for his fondness for investing in companies that have what is known as a wide economic moat. This term was popularized by Buffett to describe a company that is so good at what it does, or has a competitive advantage – such as a sole patent for a miracle drug – that it's nearly impossible to effectively compete against. Spotting these investment gems is often harder than many expect and it's a skill that Warren Buffett has perfected over decades. We’ll take a look at a few key investments that Buffett has identified, as well as other products that an average retail investor can buy in order to increase exposure to such high-quality companies.
What is Competitive Advantage?
Before we look at some investment ideas, it's important to understand that competitive advantage is the inherent ability for a company to excel at a given task in such a way that it protects its long-term profits and market share against competition. Competitive advantage comes in many forms such as pricing power, first-mover advantage, cheap access to product inputs, rights to valuable patents and a highly skilled workforce. One of the best examples of a company with a wide economic moat is the Coca-Cola Co. (KO), which Buffett identified in the late 1980s when he started accumulating a position. This move is one of Buffett’s most famous and has proved to be one of Berkshire Hathaway’s most lucrative investments. The 400 million-share position currently has a market value of $15.46 billion, or 9.10% of the company. As you can see from the chart below, Coke's slow but steady move higher makes it little wonder as to why it's been a cornerstone of Buffett’s portfolio.
Access to Wide Economic Moats for All
As mentioned above, it can be difficult for an average investor to identify companies with wide economic moats. Luckily, Van Eck Global has already done much of the legwork by creating the Market Vectors Wide Moat ETF (MOAT), which was designed to specifically track the Morningstar Wide Moat Focus Index (before fees). The ETF is comprised of a group of securities that have been identified by Morningstar, Inc. (MORN) as having a sustainable competitive advantage based on a proprietary methodology that considers both qualitative and quantitative factors. For related reading, check out Qualitative Analysis: What Makes A Company Great?.
As you can see from the chart below, the ETF is trading within a very strong long-term uptrend. It's interesting to note how the 50-day moving average (blue line) has consistently propped the price up whenever it experience short-term selling pressure (blue arrows). Over the past couple of weeks traders have seen the price near the moving average again, which is suggesting that this could be an ideal time for bullish traders to look to open a position. From a risk management perspective, placing a stop-loss order directly below the nearby moving average ($29.46) will create a favorable risk/reward ratio.
Looking at Key Holdings for Clues
The Market Vectors Wide Moat ETF trades with a relatively inexpensive management expense ratio of 0.51%. However, for investors looking to accumulate positions without investing in an ETF, one possible solution may be to focus on one or more of the 21 names held within the MOAT ETF. One name of interest is General Electric Co. (GE), which also happens to be a holding of Warren Buffett’s Berkshire Hathaway. GE currently pays investors a dividend of 3.30% and is trading within a strongly defined uptrend. Much like KO, traders will want to focus on long-term moving averages such as the one seen below in GE's chart. The current setup offers investors an interesting risk/reward ratio and there are no signals that suggest this trend should reverse.
The Bottom Line
Studying legendary investors such as Warren Buffett is one of the best ways to learn how to succeed in the stock market. For most investors, one of the best lessons is to identify companies that have wide economic moats or competitive advantages and then hold a position for the long term like Buffet has done with Coca-Cola. Investors who want to avoid the hassle of tedious research should look at the Market Vectors Wide Moat ETF, which was created to provide access to Buffett-like stocks. For more, see Economic Moats: A Successful Company’s Best Defense.