One of the best investing books I think you can read is Pat Dorsey's The Little Book That Builds Wealth.
The book is an excellent guide for identifying businesses with robust economic moats or competitive advantages.
In his book, Dorsey explains that economic moats can protect companies from the onslaught of competitors, enabling them to grow and compound earnings for many years: "Just as moats around medieval castles kept the opposition at bay, economic moats protect the high returns on capital."
The incredible power of network moats
One of the most highly prized economic moats is the network effect. This is where the value of a product or service increases with the number of users. For example, the value you get from Facebook, Inc.(NASDAQ: FB) increases as more of your friends join.
The secret power of network-based businesses, Dorsey explains, is that they often result in natural monopolies and oligopolies. Once a network like Airbnb or Google (NASDAQ: GOOGL) (NASDAQ: GOOG) gains critical mass, the force required to displace it is immense.
These 3 ASX shares have strong network moats
One of the reasons Afterpay Ltd (ASX: APT) has attracted so much attention is because it has the makings of a company with a strong network moat. Like a credit card, the more retailers that accept Afterpay, the more users will be inclined to have an account. This helps to explain the company's rapid roll-out so many big-name retailers. The more places you can use Afterpay, the more valuable it becomes to you.
Another strong network is the securities marketplace operated by ASX Ltd (ASX: ASX). The more people that use the ASX to sell their shares, the more potential buyers will show up trying to buy their shares or options at the best price. And, of course, the more trades that take place, the more money the ASX makes, which it can then reinvest to strengthen its advantage.
In a similar way, Seek Limited (ASX: SEK) has created a strong network in the recruitment space. Job hunters go to Seek websites because they know that is where the job posters go, and vice versa. It's an attractive investment proposition.
However, network moats are not impervious to competition. If a new rival can offer more features at less cost they can potentially steal the market. For Seek, this threat may come from a rival network company like LinkedIn (NYSE: LNKD).
Foolish takeaway
Network-based moats are most powerful when they connect people or exchange knowledge, rather than physical goods. Because networks can carve out dominant market positions and earn high returns, companies with network moats can make excellent additions to a long-term portfolio.
