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“Moat” is probably one of the most overused words in investing today. Every equity report has one: brand moat, distribution moat, technology moat, data moat, ecosystem moat, relationship moat, behavioural moat, runtime moat, access moat, regulatory moat – and increasingly, moats that seem to be invented specifically for the company being analysed.

A moat is not a company’s strength, or “something good about a business”. It implies a significant barrier that prevents competitors from stealing its profits.

Am not denying that genuine “moats” can provide long periods of outperformance. But the relentless advances in technology are disrupting traditional business models, and suddenly many moats are looking vulnerable. Or their longevity is now reduced.

Large FMCG companies built walls around brands and hard-to-replicate retail and distribution clout. But e-commerce has whittled away this advantage. Even apparently formidable moats can attract competition precisely because they generate attractive returns. Asian Paints is a case in point.  

Cloud computing changed software economics. AI is commoditizing software services and knowledge work. The rapid dissemination of knowledge via the Internet and AI is making it easier to replicate technologies.

But even as traditional moats are eroding, today’s analysts are inventing new ones. Just because a company is doing well, growing rapidly, is asset-light or delivers high RoCE doesn’t mean it has a moat. None of these may be enough to keep out competition. A moat usually results in superior financial metrics, but better numbers are not necessarily the result of a moat.

Today’s hot themes are defence, shipbuilding and power. Stocks supplying these sectors are flying. And high valuations are being justified by the apparent existence of moats.

One example is power transformers. Huge Capex driven by electrification, renewables, EVs, AI, grid expansion, etc. have massively boosted transformer demand, and order books are swollen. More companies are going public, and attracting a lot of investor attention.

I understand that this kind of demand boom will lift the fortunes of transformer manufacturers. But analysts are equating large order books with moats, citing manufacturing complexity or relationships with OE buyers. Is this really true?

This is a mature industry, and technology is fairly well disseminated. Yes, some players do have specialized capabilities or long customer relationships, but characterizing every player as having a moat is a bit hard to digest.

A similar thing is happening with precision manufacturing. Most of these companies cater to the auto sector, but with new opportunities in aerospace, defence and exports; their addressable markets have expanded considerably.

But does precision create an advantage that competitors cannot overcome? If dozens of companies (including SMEs) claim to have the same moat, is it any longer a moat?  

Most of the analyst reports dress up growth or performance as evidence of moats. But that may be due to business cycles, or other factors. Not every investable company needs to have a moat. But those trying to justify 50+ P/E valuations freely create moats to make their pitch more compelling.

A moat may signify superior business quality. But it doesn’t tell you whether the stock is cheap or worth investing in. Just look at what’s happened to HUL, HDFC Bank, Asian Paints and other such impregnable fortresses – negative stock returns over the last 5 years!