When he buys a stock, Warren Buffett places more emphasis on one factor above almost any other.
In fact, he has mentioned this single trait more than 20 times in his annual shareholder letters since 1986. He calls it "essential for sustained success."
And for good reason. Take the nasty financial crisis of 2008 and 2009, when the S&P 500 plunged more than 55%. Only nine stocks in the index made money during that period according to our Bloomberg screen.
Six of them had this advantage.
What is this wealth-building stock trait? It's a concept originally popularized by Buffett himself -- an economic moat.
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As Buffett once put it: "A truly great business must have an enduring "moat" that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business "castle" that is earning high returns.
"Therefore a formidable barrier such as a company's being the low-cost producer or possessing a powerful world-wide brand is essential for sustained success. Business history is filled with "Roman Candles," companies whose moats proved illusory and were soon crossed."
- Warren Buffett, 2007 Berkshire Hathaway Shareholder Letter
In other words, a business' economic moat protects it from competition and often helps it earn unusually healthy profits (and potentially market-beating stock returns).
While there isn't an exact list of moats, the most common ones are easy to spot:
Low-Cost Provider -- A company that can provide the lowest price for the same product can essentially shut its competitors out of a market. This is the reason behind Wal-Mart's (NYSE: WMT) growth over the past several decades.
High Switching Costs -- These costs keep customers loyal to a product, even if better alternatives exist. Microsoft's (Nasdaq: MSFT) Windows operating systems, for example, are still running on more than 80% of desktops, making it a hassle for consumers to "switch" in buying and learning a new operating system. And that's not to mention that many software programs are built to run only on Windows, creating another hurdle to switching.
The Network Effect -- How has Amazon (Nasdaq: AMZN) come to dominate the market in online retail? Sellers want to list their products thanks to the huge number of buyers that shop there. And buyers visit the site to find the most options from sellers. Because of their vast network of users, no other sites rival its popularity.
Strong Brand Name -- Coca-Cola (NYSE: KO) is one of the most dominant companies on the planet. Much of its advantage comes from its powerful brand name. That's why even though there are literally hundreds of soda substitutes, Coke is able to dominate its competition.
Intangible Assets -- Patents and other intangible assets (like trademarks) can protect a company from direct competition. Pharmaceutical companies, for example, have been able to pay their investors billions of dollars in dividends thanks to their patents on drugs, which shut out competition.
Investing in companies with moats is no guarantee that its stock will beat the market, as plenty of other factors come into play. But considering how frequently the world's greatest investor has touted the benefits of investing in "wide-moat" companies, and considering how well they held up during the 2008-2009 bear market, stocks carrying this wealth-building trait are worth a serious look.
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