“We like stocks that generate high returns on invested capital,” Warren Buffett told those in attendance at Berkshire’s 1995 annual meeting, “where there is a strong likelihood that it will continue to do so.”
“I look at long-term competitive advantage,” he later added, “and [whether] that’s something that’s enduring.”
According to Buffett, the economic world is divided into a small group of franchises and a much larger group of commodity businesses, most of which are not worth purchasing.
He defines a franchise as a company whose product or service (1) is needed or desired, (2) has no close substitute, and (3) is not regulated.
Individually and collectively, these create what Buffett calls a ‘moat’ – something that gives the company a clear advantage over others and protects it against incursions from the competition.