Every year shareholders of Berkshire Hathaway (BRKa) receive a special chairman's letter from the firm's CEO, investing legend Warren Buffett. For those of you unfamiliar with him (and there probably aren't many of you out there), Warren Buffett is the most successful and widely recognized value investor in modern stock market history.

And there's good reason for that fame. According to the Forbes list of wealthiest people, Warren Buffett ranks as the second-richest man in the world with a total net worth in excess of $40 billion. Even more importantly, he is one of only a handful of names on that list to attain virtually his entire wealth via investments in the stock market.

With this as a backdrop, you probably shouldn't be too surprised to learn that entire books have been written in an effort to glean every bit of investment wisdom possible from Buffett's annual shareholder letters. In particular, one concept that resurfaces time and time again in these letters is that of economic moats. In his annual letters, Buffett makes frequent references to the size of the "moat" surrounding particular companies.

But what exactly is a "moat"?

Imagine a medieval castle. Castles were traditionally part city and part defensive fortress. Constant warfare in the Middle Ages meant that cities were almost continually under siege from surrounding states.

The moat was a key part of this defense -- by surrounding the castle with water, castle builders were able to make their fortress more difficult to penetrate. A wide and deep moat would slow down aggressors and make it tough for them to scale the castle walls. The wider the moat, the more difficult it would be to attack a castle's defenders.

In today's highly competitive modern economy, companies are not unlike medieval castles. A successful company that manages to earn sizable profits will undoubtedly attract competitors. After all, it's only natural for companies to try to emulate success by copying their most profitable competitors. If those competitors are successful in gaining market share, then they'll erode the profitability of the original business.

So how do companies avoid that sort of economic siege?

The most successful firms are those that boast some sort of sustainable competitive advantage -- an advantage that's difficult to copy or emulate. These firms are able to maintain their success despite the inevitable attacks from competitors. This is what's meant by an economic moat. Companies with wide economic moats operate business models that are difficult -- or in some cases even impossible -- for competitors to attack or emulate.

Types of Moats
There are several ways of establishing a wide economic moat. In some cases, companies can establish a cost leadership position within an industry. If a firm is able to produce products more cheaply than any other firm, then they can undercut the competition and drive their rivals out of business.

Wal-Mart (WMT) provides us with a perfect example of low cost leadership in action. The world's largest retailer boasts a size and scale advantage that's difficult to emulate. The company controls so much retail space that it's able to demand the lowest possible prices from suppliers. In fact, sometimes Wal-Mart sells products to consumers at prices that are less than what's available to other retailers at the wholesale level. To some extent, Wal-Mart has been able to leverage that same advantage when entering foreign markets. Because it would take decades of successful expansion for any firm to be able to match Wal-Mart's tremendous size and scale, the company enjoys a sustainable advantage over its competition. In other words, it has a wide moat.

As our chart shows, Wal-Mart's wide moat has helped the stock outperform the S&P 500 by a sizable margin over the past 20 years. For example, a $10,000 investment in Wal-Mart back in 1985, when the company was already well known, would have ballooned to a value of nearly $500,000 by 2005. By comparison, the same cash invested in the S&P 500 would now be valued at less than $50,000.

Companies have had varied success in dealing with Wal-Mart's cost advantage. Those that have attacked the company directly by trying to compete on price alone -- grocery store chains like WinnDixie (WNDXQ.PK) spring to mind -- have fallen by the wayside. Other companies like Whole Foods (WFMI) and even Target (TGT) have adapted by targeting a more upscale clientele -- they've decided (wisely so) not to compete head-to-head with Wal-Mart. As such, Wal-Mart has retained its cost advantage in the low-end retail space throughout the last several decades.

Another common moat involves a company's brand name and image. Consumers will continually reach for their favorite brands, paying a premium price even if there are several cheaper generic equivalents on the market. A classic example is Coca-Cola (KO). Although Coke's ingredient formula is widely known in the beverage industry and can be easily reproduced, Coke still manages to charge 20% to 30% more per can when compared to generic store brands. The reason: Consumers identify with Coke and continually purchase their favorite brand. Coke's powerful brand has made the stock one of the market's best performers over the long haul.

The Dangers of Narrow Moats
Of course, most companies don't enjoy the same wide moats that have helped Wal-Mart and Coke dominate their respective industries. That doesn't mean that these firms can't be profitable and deliver decent returns for investors; a narrow moat does make it difficult, however, to sustain above-average profitability in the face of competition.

High-flying stocks with narrow economic moats are dangerous indeed. These firms can show tremendous growth for a period of time -- growth that prompts investors to jump aboard. Inevitably, however, competitors cross that narrow moat and attack the castle's advantage, eroding profitability.

One classic example of the danger of a narrow-moat firm is that of Palm handheld computers.  This firm's personal digital assistants (PDAs) took the market by storm back in the late 1990s. The company's Palm Pilot line of handhelds were bestsellers back in 1998 and 1999, and shortly afterwards parent company 3Com decided to spin off its Palm unit to a jubilant public.

Palm was initially very well received -- revenue growth was strong as the firm's Palm Pilot remained the nation's best-selling handheld. The stock was valued in the tens of billions.

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But by 2001 several major competitors had entered into this market. For example, Hewlett-Packard (HPQ) introduced a new line of handhelds, as did Sony (SNE) and Research in Motion (RIMM). Later, mobile phone companies like Nokia (NOK) and Ericsson (ERICY) began integrating PDA-like elements into their handsets. The result: Palm's product quickly became a commodity, and the firm's growth soon evaporated.

Nowadays, Palm has split into two companies -- PalmSource and PalmOne. However, these two firms are now valued at less than $1 billion combined. That represents a value of just 3% of the former highflying stock's peak valuation back in early 2000.

Individual Companies with Wide Economic Moats
With the above analysis as a backdrop, my staff and I recently went on a search for companies with wide economic moats. In doing so, we managed to hone in on a number of firms with unusually large competitive advantages. Although the exact source of their wide moats varies dramatically from firm to firm, all of these companies have the potential to keep their competitors at bay over the long haul. As a result, each and every one of these stocks should continue to perform well throughout both good times and bad.

In the analysis below you'll find in-depth profiles of several different wide-moat firms that we believe will outperform their peers in the months and years ahead...

Moody's (MCO) -- Moody's provides credit ratings as well as the analysis of credit and debt securities. The company also sells software and products that assist banks in establishing and analyzing their customers' credit. Most investors will recognize this company's widely-reported ratings system for bonds. Companies that receive the highest rating are rated Aaa, the second highest are rated Aa1, etc... Moody's has developed a total of 21 ratings to assist in the market in understanding the relative financial strength of different companies.

Thanks to the fact that the credit ratings market is heavily regulated by the federal government, Moody's enjoys a wide economic moat. The Securities and Exchange Commission has established rules and criteria that limit the competition in this market to just a handful of firms: Moody's, Standard & Poor's, Fitch and the Dominion Bond Rating Service. Moody's and S&P are by far the dominant competitors in this group with a combined 80% market share.

It would be extremely difficult for another firm to enter this market, and it's unclear if the government would even allow another competitor. In addition, many loan covenants require borrowers to maintain a certain credit rating from Moody's, and many professional money managers are only allowed to invest in bonds that are rated of a certain quality by Moody's. As a result, these companies simply must give their ratings business to Moody's in order to avoid defaulting on their loans or getting shut out of institutional investment. This provides the firm with a steady source of demand for new credit ratings.

Growth overseas is also pushing Moody's growth. In recent years, smaller European and Asian companies have entered into the market with high-yield bond issues. To attract investment from major institutional players these firms need to receive a rating from Moody's. And going forward, this trend should continue in future as foreign firms increasingly turn to the capital markets to garner funding.

As of right now, the government has no plans to change its policy towards Moody's and the other credit rating agencies. In addition, any changes would likely take years to enact, and any new competitors would likely be a fraction of Moody's size. Thanks to this enormous economic moat, Moody's should be able to sustain above-average annual growth of +15% over the long haul.

Important:  To view the remainder of this article, in which StreetAuthority.com founder Paul Tracy and his staff provide specific company names and in-depth profiles of ten additional wide-moat firms, you'll need to subscribe to our premium Market Advisor newsletter. Please visit one of the following links to continue...

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