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In business, I look for economic castles protected by unbreachable moats. -- Warren Buffett

Legendary investor Warren Buffett became the richest man in the world by investing in great businesses. When he's on the prowl for his next acquisition, Buffett loves nothing more than to find a business with a wide moat. A moat, as defined by Buffett, is a sustainable competitive advantage possessed by a business that defends it from assault by its competitors. A moat allows a business to protect its economic castle not only from smaller competitors, but also from larger ones with much more resources. Furthermore, a moat can't be easily copied - that's why it's a sustainable competitive advantage.

There are many companies with enormous moats in today's market. Sirius XM (NASDAQ:SIRI) is the only company in the country to offer premium quality satellite radio to drivers, which makes its name synonymous with its product (having Howard Stern on tap doesn't hurt either). Pfizer (NYSE:PFE) has a vast stable of valuable drug patents that its competitors cannot legally duplicate. Coca-Cola (NYSE:KO) is the most trusted brand in soda across the world. All these companies have an immense edge that allows them to remain one step ahead of their competition, and it's this kind of durable economic edge that Buffett seeks when he's looking to buy a business.

That said, there is one caveat: while the power of a moat should not be underestimated, it isn't everything. The majority of businesses don't have moats, and many still represent fantastic investment opportunities. And some of the ones that do have moats are still faced with their own unique set of challenges and headwinds. Of the three companies above, Buffett only owns one: Coca-Cola, which is probably his most famous position, a business that he says even a "ham sandwich could run."

Sirius, being a technology stock that requires investors to accurately forecast future trends, does not fall within Buffett's traditional circles of competence. However, it's worth it to note that Berkshire Hathaway (NYSE:BRK.B) recently acquired a stake in Liberty Media (NASDAQ:LMCA), which controls 40% of Sirius, so Buffett's company does own it indirectly even though he may not have been the one to make the purchase.

As for Pfizer, its most valuable asset can also be seen as the biggest weakness of its business model: its exclusive rights to manufacture a certain drug will inevitably expire, which opens the gates for generic brands to flood in. That's what happened to Lipitor last year, when the FDA began to approve generic versions of the company's cholesterol-nuking cash cow. As such, some may argue that the pharmaceutical company's moat is no true moat.

Now that we've established the significance of moats, but tempered it with the caution that a moat isn't a panacea for all your business woes, let's go back to Buffett. Buffett became famous from his success in equity investment, but for the past decade, he's been shifting gears to the acquisition of private businesses. In fact, Berkshire's equity portfolio now accounts for only a fraction of its book value - the rest comes from its huge collection of operating businesses, spread over dozens of different industries.

As expected from Buffett businesses, many of these enterprises have their own moats. For example, Burlington Northern, the railroad that Berkshire scooped up last year, is a capital intensive, heavily regulated business that operates in a pseudo-monopolistic industry, where extremely high switching costs create an almost impenetrable barrier of entry for prospective competitors. Some of Berkshire's other businesses possess similar moats, and others do not.

However, the incredibly powerful competitive advantage shared by every single Berkshire company is the simple fact that they are a Berkshire company. Most of Berkshire's businesses operate in an industry populated by similar sized competitors. Left to their own devices, these companies would fare well even without Berkshire backing - after all, Buffett acquired them because they were strong businesses before he came into the picture. However, once they got absorbed into the Berkshire family, these once capable businesses gained a valuable edge that makes them even bigger powerhouses.

Here's why: When you mess with one Berkshire company, you mess with all of them, because they all share resources with Berkshire HQ. Buffett has always said that his job is to be a capital allocator, and part of that is deploying capital towards opportunities that can enhance his existing businesses. For example, in his 2007 shareholder letter, Buffett told the story of acquiring Dennis Ulrich's gold jewelry business. When Ulrich convinced Buffett that he can expand into jewelry supply with Berkshire's financial support, Buffett acquired a supplier with Berkshire funds and merged it with Ulrich's company to form Richline Group.

Another fun fact: in his 2001 shareholder letter, Buffett noted that one of the biggest competitive advantages possessed by Berkshire's insurance companies is that they can absorb far larger losses than their competitors due to the parent company's substantial non-insurance income. An individual Berkshire business may not be all that impressive in size, but every single one of them benefits from the backing of a hundred billion dollar conglomerate, ready to step into the ring at any time.

To show this unique and devastating moat in action, let's take a look at one of Berkshire's operating businesses: Clayton Homes. Clayton sells manufactured housing, which is an industry that's been beset by problems for the past decade. While factory-built homes generally come cheaper than site-built homes, their mortgages also carry much higher interest rates because they're not guaranteed by the US government. Most home buyers cannot afford to pay the entire cost of a new house with cash, so it's been difficult for manufactured home companies, Clayton included, to attract customers.

Enter Berkshire. Not only is Berkshire a huge corporation with a massive cash hoard, until 2009, it was also one of the few companies in the US with a coveted AAA credit rating. Though it cannot borrow money as cheaply as the US government, it can borrow at a much lower rate than the small fries in the manufactured home industry. After acquiring Clayton, Berkshire leveraged its superior creditworthiness to borrow at dirt cheap rates and rerouted the money to Clayton at a 1% markup. With this edge at its disposal, its competitors didn't stand a chance. In 1998, Clayton controlled an 8% market share in the industry. As of last year, Clayton is the leading producer in manufactured housing, responsible for a staggering 47% of the total output. Game, set, and match.

Most companies in today's market are specialists who stay within the bounds of their industry for the most part and are easily defined. Pfizer is a drug company, Coca-Cola is a beverage company. Specializing is the best approach for certain industries because it ensures that you're the best at what you do, but the advantage of a generalist like Berkshire is that you can throw your massive weight around in many different sandboxes, which are often populated by businesses a lot smaller than you. Being a Berkshire company is like being the scrawny runt at the playground that no one wants to mess with, because his dad is a Navy SEAL. A Navy SEAL who's a bit psychotic, loves to fight, and has no qualms about beating the stuffing out of a little kid who's bullying his son.

Life is kind of rough when you're competing against a Berkshire company.

Disclosure: I am long BRK.A, BRK.B.

Source: Why You Don't Want To Compete Against A Berkshire Company