What are Moats and Floats?
Created on 14 Aug 2019
Wraps up in 4 Min
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Updated on 14 Aug 2021
A good business model and strong fundamentals are all fine and nice, but what differentiates a company from its competitors? Introducing - "Moat".
A very successful and consistent investor of Wall Street, Mr. Warren Buffett, who is the founder and CEO of Berkshire Hathaway, coined the term MOAT.
What is Moat?
It is a competitive advantage that a company has over other companies which are working in the same industry. Moat of a company protects its market share and profitability from the competition and is difficult to mimic or copy by competitors.
The moat word comes from the preliminary line of defense of castle and building in which deep broad ditch were created, either filled with water or mud, to protect the building from invaders. The wider the moat, the more difficult it would be for an invader to reach the castle.
Every successful company understands about the threat of their business from competitors. This competition erodes their market share with the passage of time if they do not maintain uniqueness in their business. To sustain and survive in a competitive market and to remain dominant, they need to establish an economic moat. The advantage derived from economic moat is the result of various business tactics which allows it to be consistent and above average profitable for a sustainable period of time.
Economic moat is important not only for company’s bottom line but also to seek the attention of investors willing to maximize their profit by investing in such companies which remain sustainable in an unfavorable environment by maintaining their performance edge.
A company can generate large amount of free cash flow and can have a strong track record of return through the moat on their balance sheet. For example, a company crafting a well-known brand like Nike, company with cost advantages like Walmart, company with efficient scale and network effects, etc., all these intangible assets and strengths can be utilized by businesses to create a wide economical moat.
There could be various sources of economic float. For instance -
- A company that can maintain low operating expense in relation to its sales when compared to its competitors has cost advantage and it can generate a higher volume of sales by lowering its cost. For example, Walmart stores.
- Intangible assets like patent, brands and licenses allows a company to charge a premium price to protect its production process. For example, Pharmaceutical companies earn millions due to their patent drugs.
What is Float?
In financial terms, it is the money within the banking system which are briefly counted twice due to time gaps in the registering of withdrawal and deposit, and that usually happens due to delay in the process of paper checks.
In simple words, it is advances received from customers for services or products. It often goes a long way to reduce a company’s dependence on working capital financing. An added bonus is lower interest costs.
There could be various sources of float. For instance -
- The main source of float in a bank is in the form of deposit which is made by one customer to lend out to another customer or invest it further in financial securities to produce a handsome return.
- The other source is lottery business. It may be unknown by states but lottery business also have floats when a large number of tickets are bought by gambler or consumer with the hope of winning. The state that runs the jackpot, holds the proceeds until its clearance, either in lump sum or as an annuity. In that way they hold a lot of money which really don’t belong to them. In some cases they hold that money in savings account to earn a return on float.
- Payment processing business also have float but it is in short duration. There are many companies which hold the wages and salaries of their clients and employee temporarily. Although it is difficult to invest because of extremely short duration and also an unethical practice because most of their worker doesn’t know they were receiving fewer wages than what they actually deserve and their company earns some return from the remaining fund in their checking account.
- Insurance company receives a lot of money from their policyholder and use them as their investable fund to generate return. This insurance float is used as an investment until the policyholder does not claim for it.
In a similar way there are a lot of small and medium businesses who use the concept of float to arrange their investment fund. Few more examples are, Gift cards, loyalty programs, subscription businesses and prepaid contracts, etc.
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