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Michael Mauboussin: How to Measure a Company’s Moat

In his latest article titled “Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation”, Michael Mauboussin provides a comprehensive framework for evaluating a company’s ability to create and sustain value over time.

The article provides a detailed approach to measuring a company’s moat by analyzing strategic positioning, industry dynamics, and financial metrics to assess long-term value creation potential.

Here are the key takeaways:

  • Sustainable Value Creation vs. Competitive Advantage: The article distinguishes sustainable value creation, which involves generating returns on invested capital (ROIC) that exceed the weighted average cost of capital (WACC), from sustainable competitive advantage, which also requires outperforming competitors. Multiple companies in the same industry can achieve sustainable value creation without necessarily having a competitive advantage over each other.
  • Importance of Strategy: A company’s strategy is crucial for long-term investors as it determines sustainable value creation. The spread between ROIC and WACC is a key metric, indicating whether a company’s strategy leads to value creation. The analysis includes understanding industry dynamics, firm-specific strategies, and how these translate into financial performance.
  • Industry and Firm Analysis: The article emphasizes the importance of analyzing both industry structure and firm-specific strategies. Industry analysis involves understanding factors like market share stability, profit pools, and barriers to entry using frameworks like Porter’s Five Forces. Firm analysis focuses on how individual companies add value through their unique activities and strategic positioning.
  • Barriers to Entry and Economic Moats: Identifying barriers to entry is essential for assessing a firm’s economic moat. These barriers can include economies of scale, network effects, switching costs, and regulatory advantages. The article also discusses how these factors contribute to a firm’s ability to maintain a favorable spread between ROIC and WACC.
  • Disruption and Innovation: The text explores the concept of disruptive innovation, where new entrants with different business models challenge incumbents. It highlights the importance of understanding how disruption can impact industries and firms, using examples like Blockbuster vs. Netflix.

The point of measuring the moat is to develop a grounded point of view on the magnitude and sustainability of a company’s [Return On Invested Capital] ROIC.

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