Study: Measuring Economic Moats by Comparing ROIC with WACC

Three studies:

  1. Economic Moats Sources and Outcomes by MorningStar
  2. Return on Invested Capital by InvestingMBA

    “The ROIC a business achieves over time is influenced simultaneously through its own competencies and the competitive landscape in which it operates. A mediocre business can generate high ROIC for a short
    period; however, newfound success tends to breed newfound competition. Only the truly outstanding business, backed by an identifiable competitive advantage – or economic moat – can sustain excellent ROIC in the presence of strong competitive forces.”

    ”If a company is to sustain above average ROIC for any significant length of time, it must have certain favorable qualities or competencies that give it an advantage over competition unless overall industry competitiveness is weak. It is essential to have a grasp on the qualitative aspects of the business – it’s competitive position and overall strategy – because these conditions are usually epitomized by the future ROIC.”

  3. Five Cheap Companies that Create Value – Harness the power of high returns on invested capital by Elizabeth Collins

    ”ROIC by itself doesn’t tell us much about a company’s economic moat. A company creates value only if its ROIC is higher than its weighted average cost of capital, or WACC. The WACC measures the required return on the company’s debt and equity, and takes into account the risk of the company’s operations and its use of debt. WACCs typically range between 9% and 12% for large-cap companies, although there are many exceptions. Companies that have generated ROICs higher than their WACC for many years running usually have a moat. But a positive spread between ROIC and WACC alone doesn’t justify an economic moat. Investors also have to think about the qualitative attributes–high barriers to entry, huge market share, low-cost production, corporate culture, patents, or high customer switching costs–that create an economic moat around a company’s profits. Here’s how you can use ROIC: If you think a company has a great business model that enjoys an economic moat, check to see if its historical ROICs are greater than its WACC. If they are, chances are you’ve found a company that will continue to generate value for its shareholders.”

If you are reluctant to calculate WACC by yourself (like me), you can google updated WACC for a particular company easily. If you are unable to find WACC for a particular company, you can use 15% as a benchmark.

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