Business thinker

Warren Buffett's moat, circle of competence and margin of safety

Updated 4 November 2026

Not affiliated with or endorsed by Warren Buffett or their companies.

In his letters to Berkshire Hathaway shareholders, Warren Buffett has described the ideas he uses to judge a business. Three are among the best known: an enduring moat that protects high returns from competitors, a circle of competence whose boundaries you know, and a margin of safety between value and price. This page shows which letter says what, and how to apply each to your own business or a large purchase. It is not investment advice.

An enduring moat: what protects high returns

The 2007 letter says a truly great business must have an enduring "moat" that protects excellent returns on invested capital, because competitors will repeatedly assault any business "castle" earning high returns. As examples of a formidable barrier it names being the low-cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express).

The word "enduring", the same letter explains, rules out industries prone to rapid and continuous change. It adds that a moat that must be continuously rebuilt will eventually be no moat at all.

Other letters describe what a moat is made of: the might of brand names, product attributes and distribution systems (1993), rock-bottom operating costs that virtually no competitor can match (1995), and economies of scale (1996).

When you apply it, separate a good product from a moat. A hotel laundry that is the only plant within 60 km, where a new plant would cost a competitor a large investment, has a candidate moat: something that stops others from copying its returns. "Our linen comes back cleaner" can be copied, so on its own it isn't one.

The circle of competence: know the boundary

The 1996 letter says what an investor needs is the ability to evaluate selected businesses correctly. You don't have to be an expert on every company; you only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. The 1992 letter says Berkshire tries to stick to businesses it believes it understands, which means relatively simple and stable in character.

For a business decision, the question becomes: does this decision depend on something we don't understand well? Buying a competitor in another city may sit inside your circle for running the plant and outside it for that city's customer contracts.

Margin of safety: room between value and price

In the 1992 letter, Berkshire insists on a margin of safety in its purchase price: if the calculated value of a stock is only slightly higher than its price, it isn't interested. The letter calls the margin-of-safety principle, so strongly emphasised by Ben Graham, the cornerstone of investment success. The 1997 letter returns to the "margin of safety" Graham identified as the cornerstone of intelligent investing.

For a plan or a purchase, compute the gap between the value you expect and the price or cost, then make the two most important assumptions worse and compute it again. If the gap disappears, the margin is thin.

How to apply it to your own business

1. Write down the business's margins and return on capital from your own numbers.
2. For each candidate moat (low cost, brand, distribution, scale), write the evidence and how a competitor would try to cross it.
3. Judge whether each moat will still stand in five to ten years, from how fast the industry changes and what it costs to maintain.
4. List what the deciders understand well and what they don't, and check whether the decision depends on the second list.
5. Compute value minus price, then recompute with two key assumptions made worse.
6. Write a verdict for each of the three questions and the one to three things to find out first.

What the letters say, and what they don't

Everything above comes from the Berkshire Hathaway shareholder letters of the years named. The letters are about investing and the businesses Berkshire buys; applying the ideas to reviewing your own company or another large decision is our adaptation. Neither this page nor the skill below recommends buying or selling any security.