Introduction
Popularized by Warren Buffett, the term “economic moat” refers to a sustainable competitive advantage that enables a company to protect its market share and generate high profitability over the long term. This advantage can stem from many factors such as network effects, economies of scale, strong brand recognition and high switching costs. Due to the potential financial rewards associated with investing in companies with a wide economic moat, some market participants consider these companies highly desirable.
In April 2024, S&P DJI launched the S&P 500® Economic Moat Index, which focuses on tracking companies from the S&P 500 that have been identified as having a wide economic moat. What sets this index apart is its purely quantitative approach to identifying these companies.
A quantitative approach may offer several advantages when identifying a company’s economic moat. First, it provides an objective evaluation that eliminates subjective biases that are often associated with qualitative analysis, such as anchoring bias. Second, a quantitative approach provides a standardized method of evaluation, ensuring consistent identification across industries over time. Lastly, it enables investors to examine back-tested data, which is not possible with a qualitative analyst-driven strategy. Overall, a quantitative approach offers objectivity, consistency and the ability to analyze historical performance, making it a valuable tool in identifying economic moats.
Construction Approach
Determining a company’s economic moat requires a comprehensive approach that goes beyond relying on a single quantitative measure. Instead, it requires the use of multiple metrics that complement each other. Consistency is another critical aspect to consider, as the ability to consistently generate high returns is indicative of a wide moat. Therefore, it is important to analyze the metrics over multiple periods to provide a more accurate understanding of the strength and durability of its economic moat.
