4 things you need to know about Cochlear

An economic moat is a term first coined by Warren Buffett, who said, “The key to investing… is determining the competitive advantage of any given company and, above all, the durability of that advantage.”

Cochlear (ASX: COH) is a unique proposition on the Australian stock market by virtue of developing four extremely durable competitive advantages:

1. Dominant market share: Cochlear has above 65% market share worldwide. Clinicians are setup to use its product and would be disinclined to make the switch to a competitor. This gives Cochlear pricing power that ensures it is the most expensive product in its market.

2. Switching costs: Many customers who already have Cochlear implants are reluctant to change to another brand. When the company develops a new sound processor, it has a captive market, as it only integrates with their implant. It’s something that existing customers buy, without contemplating alternatives.

3. Economies of scale: Cochlear is the largest producer of bionic ears in the world, allowing it to sell its products at a competitive cost.

4. Patents: Cochlear’s products enjoy patent protection. No one else can produce its product, or if they do, they have to pay a royalty. This gives it substantial protection against new competitors entering the market.

Cochlear’s key performance ratios bear testimony to its protected position. Net profit margins are around the 20% mark. The return on equity has been consistently high at around 40% and it has experienced steady increases in earnings per share over time. The dividend yield is 4.29 partially franked.

Foolish takeaway

In my opinion, the competitive advantages that Cochlear enjoys should almost certainly result in solid and sustainable earnings growth. However, history is full of seemingly impenetrable companies who ceded significant market share to new competitors. Remember the search engine of choice, Netscape, prior to Google? As always, remain vigilant and monitor the competitive landscape for potential disruptors.

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Motley Fool contributor Mark Woodruff does not own shares in any of the companies mentioned in this article.

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