Imagine for a moment that you own a castle filled with treasure. Without walls or any form of defence, anyone could walk in and take everything. Now think of a publicly listed company as that castle: its future profits are the treasure and its “economic moat” is the barrier that protects it from competitors, helping to ensure it continues generating cash flow for years to come.
Since the 1980s, Warren Buffett has frequently used this metaphor in his letters to shareholders to describe the competitive advantages that allow a company to fend off rivals and maintain high returns on invested capital. While the concept of an economic barrier has existed for much longer, it was Buffett who popularised the term “moat” by likening a company’s strengths to the medieval defences that once surrounded castles.
This isn’t magic; it stems from very real, tangible factors. It might be a brand so deeply embedded that consumers are willing to pay a premium, or the protection offered by a patent. It could also arise from a production process so efficient that no competitor can match its manufacturing costs. What matters is that these structural barriers force any would-be challenger to invest significantly more time or capital to win over customers, reducing their appetite for attack and helping to preserve the profitability of those already within the castle walls.
Assessing the strength of a company’s moat involves looking at two key dimensions: the scale of the advantage and its durability. First, it is important to compare the return on invested capital (ROIC) with the company’s average cost of capital (WACC). The difference between the two reflects how much additional value the company creates each year. Second, it is worth estimating how long the company can sustain that spread above the cost at which the market is willing to finance it. A recent study shows that companies classified as having a “wide moat” tend to maintain their advantage for over 20 years while those with a narrow moat rarely last two decades.
Why is this so important? Because companies that can reinvest their profits at high returns over extended periods tend to multiply their value exponentially. Just as the water in a medieval moat becomes an almost insurmountable obstacle, customers and competitors alike are often discouraged when switching providers seems more costly than beneficial. This resistance to change supports predictable cash flows, reduces earnings volatility and strengthens the company’s market position over the long term.
Major payment networks offer a clear real-world example of a moat built on the network effect: the more users and merchants accept their cards, the more value they provide to both sides and the harder it becomes for a new entrant to gain market share. Corporate software providers, for their part, benefit from high switching costs: migrating to another platform can take months and involve training, integrations and data transfers — all of which discourage customers from switching, even if a cheaper alternative exists.
But does this mean that any company with a wide moat is a safe investment? Far from it. Poor capital management or weak strategic decisions can erode even the most robust moat, undermining its breadth or depth over time. That is why, alongside analysing competitive advantage, it is essential to assess the management team’s ability to allocate resources effectively, respond to disruptive innovation and adapt strategy to changing market conditions.
Ultimately, considering a company’s economic moat before buying its shares is like examining the walls and water surrounding that investment castle. It is not enough for the treasure to be valuable, there must be a structural defence in place to prevent rivals from seizing your future profits. The wider and deeper the moat, the greater your chances of building a resilient portfolio that can grow steadily and fend off competitive onslaughts.
Diari d’Andorra, 09.07.25