Here’s How Warren Buffett Defines Great Business—and How You Should, Too

Years of a strong bull market may have given some investors the illusion that everything is going up. For a while, that’s pretty much what happened, with some growth stocks soaring in the thousands. It looks easy because it is.

Many new investors never experience a bear market, but many of the early gains are now completely wiped out. As it turns out, accumulating wealth overnight or over a few months may not be so easy.

Investing guru Warren Buffett has remained a voice of reason through decades of ups and downs, beating the market with a value-oriented approach. It’s always worth hearing what he has to say, but in this kind of market, it makes more sense to note what he’s looking for in a stock. Several factors influenced his decision, but one stood out in terms of how he defined great business.

What is a moat?

“A truly great business must have an enduring ‘moat’ that protects the excellent returns on invested capital,” Buffett said. By “moat,” he means a competitive advantage that sets a business apart from others. enterprise. In a literal sense, a moat protects a castle from oncoming attack. In a market, a moat protects a business from challengers.

There are several parts to this formula. One is that the moat must be durable. If not, it’s not real protection. It must also protect the excellent returns on invested capital, which means having those returns in the first place. If a company looks different but underperforms and underperforms, the business will fall apart despite any semblance of superiority.

some excellent examples

Buffett went on to say:

The dynamics of capitalism guarantee that competitors will repeatedly attack any commercial “castle” that earns high returns. So a strong hurdle such as a company becoming a low-cost producer…or having a strong global brand…is critical to continued success.

He gave several examples. Geico (owned by Buffett Holdings, Berkshire Hathaway) and costco wholesale Both use a discount model that is significantly better than the competition. That’s a moat because they’re hard to challenge.

As for a strong global brand, he cites Coca Cola (KO 0.72%) for example. Despite years of taste testing and debate about whether Coca-Cola is better than local non-brands, Coca-Cola can demand high pricing, and loyal customers will respond. Coca-Cola remains the world’s largest beverage brand by sales, and its unrivaled brand is a powerful sales engine that drives superior returns on investment.

Buffett also mentioned American Express (NYSE: AXP) Has a moat in its strong brand. It has a premium image and genuine perks that attract wealthy clients. Other credit card companies that cater to a wider customer base don’t have the same cachet.

Stronger Moats Lead to Better Stocks

Finding businesses with real moats can lead to higher long-term returns. Buffett said this more than 15 years ago, and the examples he gave live on today. Coca-Cola and American Express remain his top two holdings, which have delivered stellar results amid market downturns and economic turmoil. They have enduring brands and want to lead their companies into the future. Buffett sold his position in Costco in 2020, but it remains the number one stock. All of them have outperformed the market, although only Coca-Cola stock has risen so far this year.

AXP data on YCharts

A strong moat is the hallmark of a great business. Building a business requires a great business, a competitive advantage and the ability to enhance that advantage over the long term. Shifting your attention to investments that exhibit these qualities, rather than finding the next hot growth stock, can lead to more successful long-term investing.