According to Warren Buffett, an economic moat – something that makes a business difficult to disrupt – is key to a good investment. And the FTSE 100 has some great examples.
Businesses can be protected in different ways. While there’s no one competitive advantage investors should look for, there are various ways a company can differentiate itself.
Network effect
Rightmove (LSE:RMV) operates the UK’s largest property portal. And the buyers and sellers on its site benefit from each other, giving the company a powerful network effect.
When buyers are looking for houses, they look for the place that has the most listings. Equally, when vendors are looking to sell a property, they go to the place that attracts the most buyers.
On the other side of the coin, vendors have no incentive to list their houses on platforms that attract limited buyers. But buyers don’t visit sites that don’t already have a lot of properties for sale.
This is why Rightmove’s market dominance is such a big advantage over the competition. Its size provides value for both buyers and sellers, which helps it grow and further increase its advantage.
The business looks hard to displace, but CoStar – a US company – is having a go. The firm’s investing heavily to try and grow OnTheMarket, which it recently acquired.
If it can do this, CoStar’s operation will benefit from the same network effect that currently helps Rightmove maintain its dominance. But it’s going to be expensive and it isn’t guaranteed to work.
Intangible assets
Intangible assets are another important type of competitive advantage. And speciality chemical company Croda International‘s (LSE:CRDA) a great example of this.
The company has 1,500 patents that provide a significant barrier to entry for competitors. They make it legally impossible for anyone else to produce the same chemicals.
Patents therefore provide a very strong type of protection. But they typically expire after a time – usually 20 years – which means the advantage they provide doesn’t last forever.
That’s not Croda’s only defence though. Part of its business involves producing chemicals used in the pharmaceutical industry to make sure drugs are absorbed by the right part of the body.
When a drug’s approved for sale, the company’s products will often be part of the specification. This means they have to be used by manufacturers looking to distribute an approved treatment.
Being part of the specification for an approved treatment doesn’t protect Croda from someone developing a separate drug that doesn’t use its products. But that’s a lot of work and expense.
Quality businesses
I like big moats. Over time, shares in companies that have strong competitive advantages tend to generate outstanding returns for shareholders.
I think Rightmove’s network effect and the intangible assets that protect Croda International make them extremely difficult to disrupt. Competing with them would be both difficult and expensive.
There are never any guarantees with investing. But a durable advantage over the competition is something I always look for when finding stocks to buy. I think these two are worthy of further research.
This post was originally published on Motley Fool
