FINDING THE MOAT OF A COMPANY

I studied Accounting in school and for a long while since I read about the concept of company's competitive advantage (moat), I usually wonder how on earth can I know a company with a moat just by reading the financial statement.

It turns out to answer that question, I need to first understand what a most or competitive advantage is all about.

Until I know that, I will never be able to find answer on the face of a financial statement.

A moat is anything that a company possess now that gives is it an edge over others in the industry by way of increased revenue or reduced cost relative to others and hence a growing bottom line (profit).

It turns out what I will be looking for in a company with a moat is that they have a revenue growing at rate higher than that of the industry or a cost better optimized than what the industry in known for.

Then eventually, a growing profit.

Take Southwest Airline $LUV as an example, it is consistently profitable even though the industry it plays in is a fiercely competitive one. One of the secrets of that is that it pays just a little percentage of its operating income as interest expense at less than 5%.

None other in the industry pays that low.

America Airlines $AAL pays above 20%, United Airlines $UAL pays about $15% of operating income as interest expense.

The reason $LUV is ahead is not far fetched it has an advantage over others that helps it to take on minimal debt relative to others and hence a little cost of dept in form of Interest payment.

It turns out then that competitive advantage can be of any or more of the following nature:

1. Pricing (either more than that of the industry yet with volume or lower with even more volume)
2. Brand Name
3. Patents
4. Technology breakthrough
5. Customer loyalty

6. Lack of debt in the capital structure.
7. Research and Development
8. Lower depreciation of asset. etc.

Whatever a company's moat is though, it must be durable for it to enhance consistent profitability in the future. It can not be fickle. It cannot be something easily lost. It must be something unique to the company in question.

That said, I will now take you through the individual items that makes up a financial statement and explain how the likes of Warren Buffet find companies with a durable competitive advantage (moat).

Below are the components of a Financial Statement and we will take them all one after the other over the coming weeks and explain them all.

1. Income Statement
2. Statement of Financial Position
3. Statement of Cash Flow

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