The Direction of a Moat
A moat can get stronger or weaker over time, and which way it is moving usually tells you more than its width does.
Moats get graded wide, narrow, or absent. That grade describes what a business has already done. Whether the moat is growing or shrinking now is what decides the next ten years.
A smaller moat that is growing can be worth more than a larger one that is shrinking. You are paying today for years neither business has reached.
What the record shows
Three of the widest moats in American business failed. In each case the moat width was real on the day it mattered.
| Company | The moat width | The direction |
|---|---|---|
| Standard Oil | Roughly ninety percent of American refining at its peak | Competition had already pulled it toward sixty percent before the 1911 breakup |
| Kodak | Roughly ninety percent of the United States film market in the 1970s | Built a working digital camera and set it aside to protect film sales |
| Blockbuster | Thousands of stores and the largest rental network in the country | Declined the chance to acquire a young mail-order rival, and the delivery method changed underneath it |
None of their moats was still growing. It works in reverse too, and that side gets less attention: when a moat is getting stronger and nobody has noticed, the price is still set for the business as it was.
Telling a moat getting stronger from a good story
Finding a moat getting stronger early pays well. Mistaking a hopeful story for one is how people lose money, and from outside the two look alike.
A moat getting stronger is specific and you can see it in the business. Switching costs become higher this year than last. A network fills in a region. A cost advantage grows because volume grew. A story describes a future nobody has built yet.
On stocks with a hopeful story, Pets.com is the example worth keeping. The company had a great story: the first popular online pet marketplace, actually selling dog and cat food over the internet, and the thesis turned out to be correct. Investors lost money anyway. Pets.com had no advantage over anyone else selling the same bags of food, no working economics, not enough time, and it lost money on most of what it sold. Being right about the industry and wrong about the company, or about the timing, is a common way to lose money on a good story, even when the story eventually works out for someone else.
| A moat getting stronger looks like | A story looks like |
|---|---|
| Retention improving while prices rise | A large addressable market |
| Unit costs falling as volume grows | A partnership announcement |
| Share gained without cutting price | Share gained by cutting price |
| New capital earning what old capital earns | Growth funded by issuing shares |
| Competitors exiting the category | Competitors entering it |
When a moat is questioned
A new technology arrives, or a regulator, or a well-funded rival. Two questions beat picking a side.
Is the moat actually narrowing, or only feared to be? A frightening headline and a change in the economics are two different events. The headline usually comes years earlier, and sometimes the change never comes at all. A patient owner gets paid in that gap. An impatient one gets hurt in it, because some headlines are describing exactly what is happening.
If the moat is narrowing, has it reached pricing power? A moat can shrink at the edges for years while the business charges what it always charged. A premium brand can lose share and hold its prices. Once the business has to cut prices to keep customers, the erosion is in the numbers. That comes years after the first scare, when it comes.
What the price already assumes
Compare where the moat is headed against where the price says it is headed.
A price is a claim about the future, and prices tend to overstate how the market feels at the time. Sometimes a decline gets priced that never arrives, which puts a durable business on sale. Sometimes an improvement takes years to be believed, which leaves a strengthening business cheap.
The price is right most of the time. When it disagrees with you, do more work before adding conviction. Sometimes that digging shows the market missed something. More often it shows the market saw something you did not. Price and Value covers what a price contains.
Where this lands
Companies have held the widest moat in their industry right up until the direction changed. A moat that is quietly strengthening is harder to spot, and spotting one early is why the question gets asked. When a moat is questioned, separate the story from the economics, then ask whether the erosion has reached pricing power. Change the judgment when the business changes, not when a headline does.
- Moat width describes the past. Watch the direction of the moat.
- The widest moats in history still failed, and the moat width still looked reassuring while it happened.
- When a moat is getting stronger and the market has not noticed, the price is still set for the business as it was.
- A moat getting stronger shows up in the business: retention rises while prices rise, unit costs fall as volume grows, share is gained without cutting price.
- A hopeful story about an industry is not an advantage held by a company.
- When a moat is questioned, first ask whether it is truly narrowing or only feared to be.
- Erosion at the edges is survivable. Erosion that reaches pricing power is what reaches returns, and it usually arrives later than the headlines.
- A price that disagrees with you is a reason to do more work rather than proof you are early.
Watching the direction, not the snapshot.
A thesis gets re-checked as the world moves. That continuing work is what we do for clients.
How we work →Educational content only. This article is for informational and educational purposes and does not constitute personalized investment, tax, or legal advice, and does not create an advisory relationship. The concepts described are analytical frameworks rather than a method for selecting securities. Standard Oil, Kodak, Blockbuster, and Pets.com are cited as historical examples of competitive change and are not recommendations; historical accounts are summarized from the public record and simplified for education. Assessing a competitive advantage involves judgment and can be wrong. The firm and its related persons may or may not hold any security, fund, or asset class mentioned, and any such position may change at any time. No return, outcome, projection, or performance is shown or implied anywhere in this article. All investing involves risk, including possible loss of principal. Past performance does not indicate future results.
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Written by Schad TenBroeck, CFP®, Principal. CFP Board owns the marks CFP® and CERTIFIED FINANCIAL PLANNER® in the United States.