Let's figure out

  1. if the competitive advantages of some publicly-traded companies are sustainable,

  2. whether some of those companies have untapped pricing power and

  3. what those companies are worth.



A business enjoys a competitive advantage if it provides something at a lower cost, with better taste or some other perceived virtue in the mind of the customer. Warren Buffett uses the term “economic moat” when referring to sustainable competitive advantages. We analyze the moat by tracing the profitability of the company to the basic unit of analysis for the industry it operates in. This necessarily limits the set of companies discussed to the handful of industries we understand.

As obvious as this approach may seem, it is less common than one would expect. Most resources try to establish the existence of a moat by performing some mathematical operation on the financial statements of a company. Almost invariably, some number taken from the earnings statement is divided by some number from the balance sheet. The resulting quotient is thought to reveal some otherwise hidden quality. The advantage of this approach is that it can be applied to all companies across industries and time. Together with the apparent mathematical rigor, this makes this approach deeply attractive to those wishing to bring a semblance of scientific exactitude to the field of economics. In sum, many teachers and researchers in the field of economics have physics envy. 

In our view, a moat brings about the ability of a company to raise prices from current levels without losing market share. This is by definition not reflected in reported earnings. At best, the financial statements might reflect superior profitability stemming from the fact that a company has successfully raised prices. The popular approach fails to identify companies with untapped pricing power and fails to reveal the root cause of any competitive advantage.