What Lies Beneath a “Narrow Moat”?

by Investing School on April 6, 2012

The term ‘Narrow Moat’ is used to describe a small competitive advantage that one firm will have over another, competing company. Both companies will be in the same, or at least very similar, industries. This economic advantage won’t last long and provides a limited, but significant advantage to the superior company. At that point competition decreases the importance of the gap.

First used by Warren Buffet, the “Sage of Oklahoma,” this term and has gained in popularity since its inception. Today it is used in conjunction with ‘Wide Moat’ to define a number of financial conditions. A wide moat will offer significant financial benefit and is expected to last for a while. Conversely, a narrow moat lasts for a short while and will only generate a small return.

As these terms have become standardized several managers have grouped together funds which can be termed ‘narrow moats’ or ‘wide moats’ to present together in portfolios – the Morningstar Narrow Moat Index CW is such a collection of securities. Investment firms assign the designation narrow or wide moat depending upon a wide variety of criteria and market conditions. There is no actual standard. If you plan to invest based upon this determination it makes sense to find out what factors lead to the determination.

Narrow moat companies are generally regarded as good investments, but the wise investor will keep a close eye on such purchases since a firm which qualifies as a narrow moat today may be no more than an average investment tomorrow.

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