Great Business Turns Average: How Moats Get Diluted

A company can start out with one of the greatest business models in the world, a product people love, pricing power, capital light operations, recurring revenue, and a wide moat that fends off competitors.

In the early days, that kind of setup produces exactly what you’d expect: rapid growth, fat margins, and admiration from investors. It can go on for years and sometimes even decades.

But capitalism is brutal. As the original engine slows, not because it’s failing, but simply because it’s saturated its market or challenged by new innovations from competitors, management begins to look for new ways to grow. And that’s where the problems start.

Rather than returning capital to shareholders or staying focused ($AAPL has done a great job of this over the last decade), many companies use their cash flows to build or acquire new business lines. On paper, it sounds smart: diversify, expand, reach new markets. In practice, it’s often the beginning of a slow erosion of quality.

Because here’s the catch, the new businesses almost never match the economics of the original.

The Dilution of Greatness

It’s one of the most under discussed forces in investing: how a truly excellent business gets weighed down by merely good or even mediocre ventures. The original product throws off cash at 40% margins. The new ones operate at 20%, require heavy reinvestment, or worse, never make money at all.

Over time, the incredible ROIC, margin profile, and clarity of the business get diluted. Earnings quality worsens. Returns compress. And the valuation, which once made perfect sense for a business with elite economics, starts to feel expensive for a business that now looks merely decent.

A Real Example: Meta Platforms

Consider $META Facebook and Instagram are two of the most profitable digital advertising businesses ever created. They scaled globally, monetized efficiently, and printed cash. The core business had absurd economics at 35%+ operating margins, high incremental returns, and a defensible moat built on network effects and data.

But over time, that cash flow started flowing into other ventures, some sensible (like WhatsApp), some speculative (like the metaverse). The metaverse division alone lost over $10b per year at its peak. The result? A business that still owns two of the best ad platforms in the world, but whose overall margin profile has been dragged down, whose valuation has gotten harder to defend, and whose investor base became more cautious.

(Side note: I have nothing against $META stock, I am merely using it as an example here).

Why It Happens

There are a few reasons:

Incentives: Executives are paid to grow revenue and “expand the vision.” Sticking to a cash cow and returning capital isn’t always rewarded.

Legacy Thinking: Companies that built something great once assume they can do it again. But lightning rarely strikes twice, especially in unrelated domains.

Wall Street Pressure: Markets reward growth. When organic growth slows, companies look to acquisitions or other creative types of capital allocation to fill the gap.

Fear of Shrinking: Staying small, focused, and high margin is often seen as failure, even when it produces more value.

The Lesson for Investors

When you invest in a company with a great business, ask yourself not just what it is today, but what it might become.

Will they defend their core and optimize it?

Or will they chase empire building strategies and dilute what made them special in the first place?

Great businesses don’t often fail dramatically, they slowly fade quietly into mediocrity, dragged down by well intentioned but economically inferior additions. And if you’re not watching closely, you’ll still be paying a premium price for a company that no longer deserves it.

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