This Moat is Built to Last- Long Live the King!

Margie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In ancient times, the king would build a moat around his castle walls to make attacking his home more costly to other armies.

Warren Buffett, of Berkshire Hathaway (NYSE: BRK-B) has coined the term, “economic moat” to describe a company with a competitive advantage that is hard to overcome. This could be either due to a patent, a distinguishable brand name with strong positive associations, or barriers to entry-  such as capital intensive industries, government approval, etc.

In my last column explaining Groupon’s (NASDAQ: GRPN) stock free-fall, I mentioned the fact that Groupon had very few of these characteristics, and thus was quickly flooded with intense competition, which sent customer metrics downwards, and the price of shares following suit.

I briefly mentioned by way of example companies that I believe to have serious “moats” but received comments and emails disagreeing with me. Therefore, I thought I would expand on the topic, because I agree with Mr. Buffett that it is one of the most important criteria when investing in stocks long term.

Let’s take a look at two companies with really strong moats.

Facebook

Aha! I start off with one that many readers might disagree with me on. I have received comments/emails stating that all it takes is a garage full of computer programmers downing energy drinks, and parental controls on the porn (or how would they get work done) for a couple weeks to build a competitive site, and others that say, it will be any day now that 90% of Facebook (NASDAQ: FB) users dump the stupid platform.

I really want to address these mass responses/thoughts in one shot- here goes:

First of all, the computer science behind the seemingly simple interface which Facebook offers is incredibly complex. Facebook updates, in real time, billions of status updates, likes, photos, friend requests, etc. per day, as well as targeted advertising scenarios.

This requires massive amounts of data processing, servers galore, power, and incredible software architecture.

Interestingly a large part of the reason Myspace fell to Facebook was not due to stupidity of management, but because of poor software architecture. It simply took too long to add/remove features. Facebook has earned itself great accolades in the world of computer science for its handling of all its data.

Secondly, Facebook’s ubiquity of use is a major competitive advantage. Google Plus (NASDAQ: GOOG) has built a prettier platform, with some really cool features that for some reason Facebook hasn’t replicated (Live Video Hangouts for one) and yet being on Google +, despite all the resources the company has thrown behind it, is like screaming atop a distant Himalayan mountain, praying someone might hear you.

We are on Facebook because our friends are, and our friends are there because we are. It’s like a crowded bar, few people want to go the empty one across the street when their goal is to socialize.

That said, Facebook is being incredibly judicious in their placement of ads, because they don’t want to start a stampede out the doors. They built up a critical mass, and it’s theirs to lose.

Disney

I used the example of Disney (NYSE: DIS) theme parks previously and someone took issue pointing out that Sea World, Six Flags, and others existed.

Okay, granted but they cater to different crowds. Disney is a nearly perfectly vertically integrated corporation, creating brand with the Disney Channel, which sells their movies, which in turn sell stuffed toys, which in turn sell the theme parks.

Making movies is not an easy business, there’s tremendously high risk. Let’s say you had the talent to make another Star Wars like movie, (a franchise which Disney recently purchased for 4 billion from George Lucas) and you wanted to market it, create the toys, and develop a theme park.

Would a billion dollars be enough? You’d likely spend $300 million on the movie alone …

And every child knows who Mickey Mouse is. Every single child in America. This is a time tested brand, built over time. They have a huge competitive advantage; and huge capital is required to enter into the market. Moat? Big time!

The Takeaway

I use these examples primarily because I have heard from too many investors (especially in regards to Facebook) that they have no “moat,” and so I thought I would explain not only why these companies do, in my opinion, have super-wide moats, but also to give you something to think about to apply in your own investment thesis.

It’s not rocket science, but it does take some understanding and thought.

As I enjoy learning from people who are successful, and incorporate their strategies into my own investment decisions, allow me to say Mr. Buffett, “This moat’s for you! Long live the King!”

 


margiecfl has positions in Google and Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway, Walt Disney, Facebook, and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Berkshire Hathaway, Walt Disney, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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