How to Evaluate Moats Like a Hedge Fund Pro

Easy as One, Two, ChatGPT

April 04, 2025

Hello Investor,

When hedge funds evaluate a stock, they don’t just look at valuation or earnings. They obsess over the quality and durability of a company’s moat — the competitive edge that protects its profits for years to come.

Today, you’ll learn how to spot moats like a pro, break them down using proven frameworks, and even use ChatGPT to assist your research.

What is a Moat — and Why It Matters

A moat is a structural advantage that shields a company from competition. Think of it as the economic version of a castle’s defenses.

Why it matters:

✅ Companies with strong moats tend to earn higher returns on capital
✅ They can withstand downturns and competitive attacks
✅ Moat stocks often deliver long-term compounding

Legendary investors like Warren Buffett look for “wide-moat” companies — and hedge funds do the same, but with more structured tools.

The 5 Types of Moats (Institutional Lens)

These are the five categories hedge funds use to classify and evaluate moats:

  1. Cost Advantage – Scale or tech allows for cheaper production.
    Example: Walmart or Costco.

  2. Network Effects – More users = more value = more defensibility.
    Example: Visa, LinkedIn, or Meta.

  3. Intangible Assets – IP, patents, brand equity, or exclusive rights.
    Example: Coca-Cola, Pfizer, or Moody’s.

  4. Switching Costs – Customers face pain, risk, or expense when switching.
    Example: Adobe or Salesforce.

  5. Efficient Scale – Market is too small for multiple players to profit.
    Example: Regional utilities or toll road operators.

Not all moats are equal — the wider and more layered, the better.

How Pros Evaluate Moats with Porter’s Five Forces

Hedge funds don’t just describe moats — they pressure-test them using Porter’s Five Forces, a strategic framework for assessing industry strength:

Force

Ask Yourself

1. Threat of New Entrants

Can new players easily disrupt this space?

2. Bargaining Power of Suppliers

Can suppliers squeeze the company’s margins?

3. Bargaining Power of Buyers

Do customers have other options or leverage?

4. Threat of Substitutes

Can other products make this obsolete?

5. Competitive Rivalry

Is this a pricing war or value war market?

Institutional analysts often use these forces to score a company’s moat from 1 (weak) to 5 (strong), mapping out vulnerabilities.

Signs of a Weakening Moat

Even wide moats can erode. Smart investors constantly reassess for cracks:

  • Falling ROIC (Return on Invested Capital)

  • Margin compression despite revenue growth

  • Increased churn or declining Net Promoter Score (NPS)

  • New entrants eating into market share

  • Management shift away from innovation or R&D

This is where many retail investors fall behind — but you won’t.

Use These ChatGPT Prompts to Evaluate Moats (Fast)

Here are practical prompts to speed up your analysis using ChatGPT:

✅ Basic Moat Diagnosis

“Act as a hedge fund analyst. Summarize the competitive moat of [company name] and which of the 5 moat types apply.”

✅ Porter’s Five Forces Breakdown

“Using Porter’s Five Forces, evaluate the industry dynamics for [company name] and describe how defensible their position is.”

✅ Spot Vulnerabilities

“List three potential risks that could erode [company name]’s competitive advantage over the next 3–5 years.”

✅ Compare Two Stocks

“Compare [Company A] and [Company B] in terms of their moats — use cost advantage, network effects, and switching costs.”

You can copy, paste, and refine these for any stock you’re researching.

🔥 Want Access to Done-for-You, Plug-and-Play ChatGPT Prompts That You Can Use to Crush the Stock Market?

Get access to our comprehensive hedge fund moat analysis prompt that goes 10x deeper than anything in our free newsletters.

Moats Make or Break Long-Term Winners

Moats aren’t just nice to have — they’re often the difference between a 2x and a 20x stock.

Ask yourself:

➡️ Is this business hard to compete with?
➡️ Is its moat getting wider… or thinner?
➡️ Are there vulnerabilities on the horizon?

Would you like us to follow this up with a real-world case study breakdown (e.g., “Apple vs. Microsoft: Who Has the Stronger Moat?”)?

Let us know — and we’ll build it.

Best regards,
StocksTrades.AI Newsletter

Disclaimer: This newsletter is for informational purposes only and does not constitute financial advice. Always do your own research.