Credit: Shutterstock photoA company's competitive advantage is becoming increasingly important in a world where intangible assets dominate the balance sheets of the Standard & Poor's 500's largest companies.
Warren Buffett ( Trades , Portfolio ) is one investor who has always been aware of the power of the competitive advantage and has invested with the competitive advantage in mind ever since the '60s. Other investors may have taken longer to realize the power of competitive advantages than Buffett, but today such economic moats feature heavily in investment theses.
The question most investors now find themselves asking is how to value such intangible assets. How do you place a value on something that might seem valuable today but could lose all of its value in a heartbeat if its reputation is destroyed?
To try and answer this question, I've been looking at some of Buffett's essays and letters to investors over the years.
The key to the long-term advantage
Ironically, one of the best quotes describing how to value a competitive advantage comes not from Buffett but from Charlie Munger (Trades, Portfolio):
Only by figuring out what the competitive advantage is in the first place will you be able to establish if the advantage can continue to exist.
After figuring out the definite advantage, it is then time to determine how big the advantage is over competitors. How easy would it be to re-create the business? Are there barriers to entry? What makes the company so unique that allows it to maintain high returns? What could change that? A business with high margins and low barriers to entry is unlikely to be able to keep those margins for long:
So what are the hallmarks of a sustainable competitive advantage?Buffett's 2007 letter to Berkshire Hathaway ( NYSE:BRK.A)(NYSE:BRK.B) shareholders contains some great examples of what he believes are businesses with the best competitive advantages and their returns. For example:
There's also See's Candies:
And then all of the other businesses Berkshire owned at the time:
Finally, the worst types of businesses:
Disclosure: The author owns no stock mentioned.
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This article first appeared on GuruFocus .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
