| Mean reversion of profitability has long been recognized by scholars. For example, Fama and French (2000, p. 161) states that “in a competitive environment, profitability is mean reverting within as well as across industries. Other firms eventually mimic innovative products and technologies that produce above normal profitability for a firm.” Some “investment gurus” like Warren Buffett, however, believe that there are a few firms that are shielded, to some degree, from the erosion of higher profitability. They believe those are firms that have sustainable competitive advantage as the defense against competition. Warren Buffett used the term moat to describe this advantage. The success of Warren Buffett and his peers is often credited with their ability to identify firms with sustainable competitive advantage3 . Many practitioners believe that investing in stocks with a wide moat is the recipe of long term superior stock performance4 . In fact, there is even an ETF named “moat” that is created to capture the supposed outperformance of wide moat firms.5 Do stocks with a wide moat outperform stocks with no moat? Without an empirical test, it remains an urban legend. First, moat is intangible and difficult to measure. Second, there is no empirical evidence that wide moat firms are free from erosion of higher profitability. Third, even if wide moat firms have enduring higher profitability, this “sustainable competitive advantage” might have been reflected in their stock market price in an efficient market. As a result, stocks with wide moat could be expensive, but do not lead to higher returns. |