Warren Buffett, who?s one of the (if not the) best investors in the world, is constantly talking about the importance of investing in companies with a strong economic moat.
Put simply, an economic moat is the competitive advantage that a company has which will help keep the firm?s competitors at bay, much like how a medieval castle has a moat of water to keep invaders out (see picture above).
Although moats are important for investors, it?s important to know that not many companies have a truly enduring moat. With this in mind, I?d be taking a look at two blue chips…
Warren Buffett, who’s one of the (if not the) best investors in the world, is constantly talking about the importance of investing in companies with a strong economic moat.
Put simply, an economic moat is the competitive advantage that a company has which will help keep the firm’s competitors at bay, much like how a medieval castle has a moat of water to keep invaders out (see picture above).
Although moats are important for investors, it’s important to know that not many companies have a truly enduring moat. With this in mind, I’d be taking a look at two blue chips (companies which make up Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI), are commonly known as blue chips) to see if they have what it takes to be admired by Buffett.
The first company on my list is Starhub Ltd (SGX: CC3), the second largest telecommunication services provider in Singapore. Starhub, with a purely local business providing customers with services that include mobile, internet, cable television and more, competes directly with M1 Ltd (SGX: B2F) and Singapore Telecommunications Limited (SGX: Z74) on a number of different fronts.
From the perspective of a customer, he or she can switch easily between the different telcos; the ease of switching is aided by the fact that all three companies offer similar products and services. Even if there is a difference between the level of service that each company provides, there is no restriction which can prevent a competitor from one-upping Starhub’s service standards.
When we take all that I’ve described into account, it’d appear that Starhub may not possess a strong economic moat which can prevent competitors from stealing market share.
The second company I’d be discussing is United Overseas Bank Ltd (SGX: U11), one of Singapore’s largest financial institutions and a competitor to many other banks including DBS Group Holdings Ltd (SGX: D05) and Oversea-Chinese Banking Corporation Ltd (SGX: O39) in both the local and regional banking markets.
A bank’s most basic business is to gather deposits and then loan them out; the bank earns its keep by collecting the spread between the interest it pays on its deposits and the interest it receives from the loans it has made.
In this sense, there are two important perspectives to understand when it comes to analysing a bank’s economic moat – the depositor’s perspective and the borrower’s perspective.
From a depositor’s vantage point, so long as a bank can offer a good interest rate for deposit accounts along with being financially sound (depositors can suffer if a bank goes kaput), there isn’t much to choose from between different banks. When we switch to a borrower’s perspective, it’s most likely that the borrower will pick the bank which can provide the cheapest loans for him or her.
These mean that banks are basically competing on the basis of who can offer a cheaper price for loans (or higher interest rates for deposits) and that does not seem to be a foundation on which strong economic moats can be built upon.
We have seen that even for large companies with only a few competitors, the ability to create a lasting economic moat is not easy.
Even though both Starhub and United Overseas Bank are considered big firms in their respective markets, they do not seem to possess strong economic moats that can provide a resolute defence against their competitors.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.