This is how Warren Buffett defines big business — and how you should too

The strong bull market for many years may have given some investors the false impression that everything is going up. For a while, that’s pretty much what happened, with the prices of some growth stocks skyrocketing with percent gains in the thousands. It seemed easy, because it was.

Not many new investors experienced a bear market, but many of those early gains have now been completely wiped out. It turns out that it may not be easy to accumulate wealth overnight or over the course of months.

One consistent voice of reason through decades of ups and downs is expert investor Warren Buffett, who has beaten the market with his value-oriented approach. It always pays to listen to what he has to say, but in this type of market it makes more sense to note what he is looking at in a stock. There are many factors that determine his decisions, but one factor that stands out is how he defines great work.

What is a trench?

“A truly great business should have a permanent ‘ditch’ that protects excellent returns on invested capital,” says Buffett. The “trench” he’s talking about refers to a Competitive advantage Which makes the work unique and better than others. In the literal sense, the moat protects the castle from incoming attacks. In the markets, the moat protects the company from competitors.

There are several parts to this formula. The first is that the moat must continue. If not, it is not really protective. It should also protect excellent returns on invested capital, which means those need to be there in the first place. If a company appears differentiated but does not perform and publish excellent results, the business will fall apart despite any ostensible advantages.

Some excellent examples

Buffett goes on to say:

The dynamics of capitalism ensure that competitors will frequently attack any commercial “fortress” that generates high returns. Therefore, a massive barrier such as being a low-cost producer…or having a strong global brand…is essential to continued success.

He gives several examples. Geico (owned by Buffett Holdings Inc., Berkshire Hathaway) And the Costco Wholesale Both operate with a convincingly better discount model than competitors. This is a moat, because it is difficult to challenge them both.

As for a strong global brand, he said coca cola (Ko 0.72%) as an example. Despite years of taste-testing and discussions about whether or not Coca-Cola is better than your local brand, Coca-Cola can command high prices, and loyal customers respond. Coca-Cola remains the world’s largest beverage brand by sales, and its unbeatable brand is a strong sales generator, delivering excellent returns on invested capital.

Buffett mentions too American Express (NYSE: AXP) As having a ditch in its strong brand. It has an excellent image with real perks that attract wealthy clients. Other credit card companies that cater to a wider mix of customers do not bear the same character.

Strong trenches lead to better stocks

Finding companies with real moats can lead to higher gains in the long run. Buffett made these observations more than 15 years ago, and the examples he mentioned have already persisted. Coca-Cola and American Express Two of his most important possessions remainThey have achieved outstanding results in a stagnant market and volatile economy. Their brands have stood the test of time and look forward to carrying their company well into the future. Buffett sold his position at Costco in 2020, but he also remains a big stock. Although only Coca-Cola stock has shown gains so far this year, all of these stocks are outperforming the market.

AXP . chart

AXP data by YCharts

A strong moat is a sign of great action. Building an excellent business requires a competitive advantage and the ability to build that advantage over the long term. Shifting your focus to investments that demonstrate these qualities, rather than looking for the next fast-growing stock, can lead to a more successful investment in the long run.

American Express is the advertising partner of The Ascent, the Motley Fool Company. Jennifer Seibel He has positions at American Express. Motley Fool has positions in Berkshire Hathaway (B stock) and Costco Wholesale and recommends. Motley Fool recommends the following options: long January 2023 calls of $200 on Berkshire Hathaway (B shares), January 2024 long calls of $47.50 on Coca-Cola, and short January 2023 calls of $200 on Berkshire Hathaway (B shares) , and short January 2023 calls for $265 on Berkshire Hathaway (B shares). Motley Fool has a profile Disclosure Policy.

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