Novice Investing - Calculating Business Moat

Date: Monday 13th 2008f October 2008 10:52:22 AM

Calculating Business Moat - 03/26/2006

By: Hari Wibowo

First of all, what is the definition of a business moat? A moat is something that hinders competitors to 'attack' a company's castle. In other words, it is a blockage that deters competitors from imitating a firm's business products. Obviously, investors need to invest in companies with a very wide moat. That way, a wide-moat company can have pricing power, as well as higher profits.

Surely, companies with recognizable brand name will have a moat of some kind, compared to generic brand. If customers are willing to pay a premium for your product, then your business do have a moat. That being said, how do we determine a company's moat for valuation purpose?

There is no definite ways of doing this. But, you can do a simple pricing research for the company in question. For example, if consumers are willing to pay $ 0.10 more for each bottle of Coke over the competition, this is then the result of Coke's business moat. Multiplying the number of bottles sold each year, will gives you the additional revenue due to the firm's business moat. As a matter of fact, this price difference goes straight to the firm's net income.

A lot of people like short-cut. So, perhaps you will like this short-cut way of evaluating business moat. Here is the way I see it. Companies with business moat will have an above average net profit margin. Recall that business moat will give a firm additional profit for each unit sold. This will result in a higher net profit margin. By definition, net profit margin is the percentage of profit with respect to net sales.

Let us look at applicable examples of a business moat. Almost everyone agrees that Wal-Mart Stores Inc. (WMT) has some kind of business moat. It is the biggest retailer in the world with sales totaling $ 250 Billion in a given year. Without further ado, let us find out what Walmart's net profit margin for year 2005. For 2005, Walmart reported total sales of $ 314.8 Billion. Net profit came in at $ 11.230 Billion. Therefore, Walmart has a net profit margin of 3.57%. Is this good? According to retailers.com, average large retail stores has a profit margin of 2% in 2000. From here, we can conclude

that Walmart business moat contributes an additional 1.57% of sales or $ 4.94 Billion. Being able to convince your customers to pay $ 4.94 Billion more is no small feat. That, on itself, tells you about the scale of Walmart's business moat. It is no wonder that many Mom and Pop's stores has become victims of Walmart's success.

Please note that business moat do not always involve company's brand. A few other attributes that can produce moat are: patent, location, efficient inventory management and size.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Wal-Mat Stores Inc. (WMT) or any other securities.

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