“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”

-Warren Buffett, Fortune Magazine

Warren Buffet knows a thing or two about investing. Before you can pick good stocks, you have to find good businesses, and you can analyze the strength of a business by examining its competitive advantage, so let’s go through the different types.

Ever seen the show NCIS? It’s a personal favorite, and it stands for “Naval Criminal Investigative Service.” Fortunately, the acronym also works for remembering the four types of competitive advantage:

The Four Sources of Economic Moats

NCIS: Network Effects, Cost Advantages, Intangible Assets, Switching Costs

1)      Network Effects (eBay, Facebook)

Explanation: Can you imagine Facebook with three users? It would be pretty worthless. However, the more users that join it, the more valuable it becomes. We call this the network effect.

2)      Cost Advantages

1. Economies of Scale (Walmart)
2. Geographic Advantages (Miners)

Explanation: Ever wonder why Walmart can charge the lowest prices? It sells more products than anyone in the world, so it has incredible bargaining power when it “buys in bulk.” Therefore, they get to buy their products from their suppliers at the cheapest prices, and then they pass those along to the customer.

3)      Intangible Assets

1. Brands (Under Armour)
2. Patents (Healthcare)
3. Regulatory Licenses

Explanation: You have to be very careful with intangible assets because it is very easy to mistake a brand for competitive advantage. With a case like Under Armour though, the company still has over 70% of the compression shirt market, even though Nike and Adidas have come out with identical products. The product is essentially called “Under Armour” now. Their brand is definitely a competitive advantage.

4)      Switching Costs

1. Tight Integration with Businesses (Microsoft)
2. Retraining Costs
3. Contractual Obligation (Verizon)

Explanation: Microsoft is so established with businesses that it would be a huge pain to switch. This allows them to charge higher prices over time and get away with it because it is not worth the hassle of switching.

Being able to analyze competitive advantage is crucial because it can help you separate great companies that can grow for years from short-term fads that will be overrun by the competition.

Four Mistaken Moats:

1. Great Products
2. Market Share
3. Operational Efficiency
4. Talented Management

Hopefully, this article gives you a better sense of how to analyze a company’s competitive advantage. Make sure to keep these ideas in mind as you start thinking about your favorite companies. Head to our forum to discuss this post and competitive advantage with other members.

This article was written by Connor Haley and the CollegeStockPicks.com team