How to pick better shares and earn better returns

Unsure how to pick decent ASX shares? In order to earn better returns, consider looking at these four types of economic moats.

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

I have tried a lot of different approaches to picking good shares to invest in over the last ten years. From buying shares in small-cap growth companies to 'bargain' commodity producers.

The most successful approach I've found when picking shares has actually been one of the simplest: looking for companies with strong economic moats.

What is an 'economic moat'?

An 'economic moat' is another name for a competitive advantage. It is a feature that is hard to replicate which protects a company's earnings from the onslaught of competition. Just like a moat protects a castle.

Companies with economic moats can be an investors' best friend. By being insulated from competition companies, they are able to generate above-average returns on capital. By reinvesting that cash, these companies can compound and grow dramatically over time. 

Many of the best-performing ASX-listed companies have strong economic moats. If we pick these companies as a core part of our portfolio, we stand a good chance of earning better returns.

The 4 types of economic moat

In his book 'The Little Book That Builds Wealth' author Pat Dorsey outlines four categories of economic moat to look for when picking a company to invest in:

  • Intangible assets
  • Customer switching costs
  • The network effect
  • Cost advantages

Intangible assets can include brands and patents. Blood product company CSL Limited (ASX: CSL) is an example of a company which, through years of research and acquisitions, has created a valuable portfolio of patents and product licences.

Accounting platform Xero Limited (ASX: XRO) is an example of a company with high customer switching costs. Because there is a lot of time and hassle involved with changing to a new accounting system, the cost to switch can be prohibitive.

Despite the rise of Linkedin, jobs platform Seek Limited (ASX: SEK) has proved to be a robust example of the network effect where growing additional users creates more value for other users.

While JB Hi-Fi Limited (ASX: JBH) is an example of a company that has thrived using cost advantages to reduce prices for consumers and win market share.

Growing your money with great companies

I think economic moats are useful criteria for picking decent companies that will earn high share returns. However, to really get the best result we need to have patience; the patience to buy shares at bargain prices and the patience to let returns compound for long periods. That is the hard part.

Should you invest $1,000 in Dicker Data right now?

Before you buy Dicker Data shares, consider this:

Motley Fool investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and Dicker Data wasn't one of them.

The online investing service he’s run for over a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

And right now, Scott thinks there are 5 stocks that may be better buys...

See The 5 Stocks *Returns as of 30 April 2025

Regan Pearson owns shares of Xero. You can follow Regan on Twitter @Regan_Invests.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. and Xero. The Motley Fool Australia has recommended SEEK Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on How to invest

A businesswoman weighs up the stack of cash she receives, with the pile in one hand significantly more than the other hand.
How to invest

How I'd build a $20,000 annual passive income stream from these top ASX 200 shares

To earn $20,000 a year in passive income, I’d start with these three ASX 200 shares.

Read more »

a smiling picture of legendary US investment guru Warren Buffett.
How to invest

Life after Warren Buffett: other successful investors still in the game worth following

With Warren Buffett retiring it’s time to look at some other investors delivering solid returns.  

Read more »

An older woman gazes over the top of her glasses with a quizzical expression as if she is considering some information.
How to invest

How to build an ASX ETF portfolio to match your risk profile

Time for a portfolio review?

Read more »

A man sits cross-legged in a zen pose on top of his desk as papers fly around his head, keeping calm amid the volatility.
How to invest

Why market volatility is an ASX stock picker's best friend

Here's why you shouldn't fear market volatility.

Read more »

A businessman compares the growth trajectory of property versus shares.
How to invest

Why does Warren Buffett prefer shares over property?

Equities made Buffett the world's most successful investor.

Read more »

Person holding Australian dollar notes, symbolising dividends.
How to invest

Should I spend $5,000 on ASX 200 shares or ASX ETFs this month?

Where is the best place to invest these funds? Let's look at the options.

Read more »

a smiling picture of legendary US investment guru Warren Buffett.
How to invest

2 famous investors with even better track records than Warren Buffett

These two fellow Americans achieved mind blowing returns.

Read more »

A group of young ASX investors sitting around a laptop with an older lady standing behind them explaining how investing works.
How to invest

How a beginner investor could build a $250,000 ASX share portfolio

These easy steps could help you on your way to riches in the share market.

Read more »