Economic moat

The term was popularised by Warren Buffett, who likened a great business to a castle whose profits are defended by a moat that competitors cannot easily cross. High profits normally attract competition, which tends to push returns down towards average. A company with a moat can keep earning above-average returns on its capital for many years. Common sources include network effects, where a product becomes more valuable as more people use it; high switching costs for customers; intangible assets such as brands, patents and licences; lasting cost advantages; and markets only big enough for one or two efficient suppliers.

Moats matter to investors because the value of a business depends heavily on how long it can sustain high returns. A company earning strong profits today without a moat may see them competed away, while one with a durable moat can compound its value for decades. Moats are judged, not measured, and they can erode through new technology, regulation or management mistakes. Nor does a strong moat make a share a good investment at any price: if the market already values the advantage fully, returns from buying the shares can still be poor.