Warren Buffet always used to look for a company’s moat while assessing potential investments. The Oracle of Omaha says that his success mantra is simply investing in businesses that have a definite moat around them. That is firms must possess a competitive advantage that allows them to maintain pricing power. But what most of us tend to overlook is the latter part of the moat strategy – even businesses with moats should be bought at a reasonable price.

Undoubtedly, these businesses are excellent contenders for portfolios focused in capital protection. But are they worthy of capital appreciation is the question that is left unanswered.

In reality, there are only two types of market corrections: price and time.

Price correction

To put it simply, a price correction is a reverse movement in a stock’s price from its peak. Investment in a business with moat means price correction is definitely taken care of, and your capital is protected. Why?

It’s simply because these businesses have emerged as the leaders in their segments, with their products generating way more cash that they burn. These moat businesses generate cash with certainty. So, they are also referred to as `Cash Cows.'

Every cash cow is a business with a moat. But not all business with moats become cash cows. Just look at Zomato’s money-losing, cash-burning business (without raising any questions about whether or not it holds immense potential)!

Booming markets surely wouldn’t leave behind the discovered businesses with moats, which leads to abnormal price rise and price-to-earnings (P/E) expansions. As a matter of fact, it’s almost impossible to find a business that has a moat and is available at a fair price in a bull-run!

Avoid buying businesses with moats in a bull market as stock prices would be at absurdly high levels. If you happen to do so, you are bound to be a victim of price corrections.

Time correction

Time correction is basically an extended period of no significant price movement, either upside or downside. And more often than not, the reason this happens is because of lack of growth.

If your moat business isn’t investing in its growth or, in other words, making an attempt to increase the free cash flows, then time correction would be taking a toll on your returns.

What happens with a moat businesses is that they keep growing, increasing sales, capturing more and more market share. But there eventually comes a time when growth stagnates. Although the sales and earnings numbers are huge, there’s no more room for any growth. The small fish has grown to now become a huge shark.

Take Infosys as an example. The company had turned into a huge cash cow in the early 2000s. It started trading at an unjustifiable P/E of around 100. So, the stock price did not move as much in the next five years. In times of rising inflation, when the stock does not perform, an investor is certainly destroying his or her wealth.

Cash cows are always going to be a profitable for the promoters, but this is not the case for retail investors. And that’s because our entry point will only be when we discover this cash cow, a very different one from the promoter. As retail investors, we’d want the stock price to keep increasing but the enormous free cash generated from its successful moat business has already been priced in.

To avoid stagnation, our shark has to chase growth and expand its business avenues, add capex and generate other streams of cash flow. Only if your cash cow moat business is chasing growth, is it fit for capital appreciation. If not, all that these excellent moats are doing for your portfolio is capital protection.