The French mocking King Arthur from their moat. Pic: Python (Monty) Pictures

Moats.

Yes, you read that correctly and no, it’s not a typo: moats are one of the two most important things to consider when investing a stock, alongside company culture, according to a fund manager.

Investors are making crucial mistakes by not taking these two factors into consideration, says Kurt Winlich, portfolio manager at WCM Investment Management.

Mr Winlich refers to Warren Buffet’s ‘economic moat’: a business is like a castle and its moat is the company’s competitive advantage it wields to protect long-term profit and market share.

But, he says, the concept is a little outdated and investors should be looking at companies with an increasing moat, that is a company with a rising return on investment capital.

“The direction of a company’s competitive advantage or economic moat is of more importance than its absolute size,” he says.

“The critical idea is how the competitive advantage is changing—is it getting stronger, or is it getting weaker? It’s the direction of change that matters, not the absolute level.

“Does the company have some kind of long-term growth path in front of it; is the industry it is within set for secular growth, or secular decline? If the global demand for a company’s products is shrinking, or worse, if the product has been made irrelevant by a change in consumer preferences, this can be quite dangerous.”

It can be tempting to invest in large, established companies as a safety net but Mr Winlich says this is a risk, pointing to the likes of Nokia, Blackberry and Yahoo as companies with “deteriorating moats”.

“If the organisation is losing its edge, either by declining market share or some other aspect of its moat, then that organisation may experience challenges and ultimately its share price will suffer,” he says.

A harbinger of whether a stock will be a good, long-term investment, is its culture.

Mr Winlich argues that many investors underestimate its importance as it is considered a more “soft” aspect of a business.

“Corporate culture is the biggest influence on a company’s ability to grow its competitive advantage, its moat,” he says.

“When a company culture is poor, this can lead to issues such as slow delivery, poor service or rude employees, all of which can affect the customer experience and the company’s long-term financial performance. In contrast, companies with great service and employees that go the extra mile rarely have complaints made against them. And if they’re not making complaints, customers will return to the better businesses, leading of course to better business results. It’s that simple.”