The Sheldon Scale is a humorous and insightful framework for classifying the strength of a company's economic moat. Coined by noted investor Pat Dorsey, the scale is an informal tribute to Sheldon Cooper, the beloved, classification-obsessed character from the TV show The Big Bang Theory. It provides a simple, memorable way for investors to move beyond simply identifying a competitive advantage to actually grading its quality and durability. The scale runs from 0 (a business with no competitive advantage whatsoever) to 5 (a nearly unbreachable fortress). For a value investor, this kind of qualitative ranking is invaluable. It serves as a powerful mental model to avoid overpaying for mediocre businesses and to better appreciate the long-term value of a company with a truly sustainable edge.
The Sheldon Scale isn't a scientific formula but rather a practical heuristic. It helps an investor quickly size up a company's competitive landscape using relatable analogies. The core idea is to assess how well a business can defend its profits from competitors over the long haul. A weak moat might protect a company for a year or two, while a wide moat can secure its position for decades.
Pat Dorsey assigned clever, descriptive names to each level, making the concept stick. Here’s a breakdown from worst to best:
This is a company with no moat at all. It sells a pure commodity product or service with zero differentiation, has no pricing power, and faces brutal competition. Think of a generic gadget manufacturer or a restaurant in a crowded food court. The name humorously implies a product so useless and undifferentiated that it has no reason to exist. These businesses rarely generate sustainable returns.
This company has a temporary advantage, like a new feature or a slightly better product. The problem? The advantage is easily copied. Competitors will quickly catch up, and the “better mousetrap” will soon become the industry standard. This leads to a constant, expensive race to innovate without creating lasting value.
This refers to businesses with a solid local or niche advantage. Think of a well-located quarry or a regional brand that is beloved in its home state but has little recognition elsewhere. Like the movie's mantra, “If you build it, they will come,” this moat works, but only within a limited field. It's a narrow moat, but a real one.
A step up from the “Field of Dreams,” this company has a more formidable narrow moat. The competitive advantage is clear and defensible, often stemming from network effects in a specific region or high switching costs for a particular customer base. A regional railroad or a dominant local waste management company are great examples. They are tough to beat on their home turf.
This is the sweet spot for long-term investors. A “Wide Moat” company has a durable, powerful competitive advantage that is difficult to assail. The source of this power typically comes from one of four places: deep intangible assets (e.g., the Coca-Cola brand), high switching costs (e.g., your bank), a network effect (e.g., Facebook), or a significant cost advantage (e.g., Walmart's logistics).
The rarest of all. This company has a moat so powerful it seems almost permanent, often combining multiple wide-moat sources. Historically, companies like Moody's in the credit rating space or a business with a government-protected monopoly might fit here. Finding a true Level 5 company is an investor's dream, as they can compound capital for generations.
While fun, the scale has serious practical applications for investors practicing value investing. It provides a structured way to think about one of the most important factors in a company's long-term success.
Investing is full of noise. The Sheldon Scale cuts through it by focusing your attention on a single, critical question: How durable is this company's competitive advantage? It forces you to think qualitatively and critically about the business itself, rather than getting lost in short-term market fluctuations. By assigning a number, you are forced to justify your assessment of the company's moat, leading to a deeper understanding of the investment thesis.
The strength of a company's moat is directly linked to the price an investor should be willing to pay for its stock. A Level 4 or 5 company can reliably grow its earnings for years and therefore may justify a higher valuation (like a higher P/E ratio) than a Level 1 company. A common mistake is to pay a “wide moat” price for a “better mousetrap” business. By using the Sheldon Scale, you can better align the price you pay with the quality of the business you are getting, helping you build a solid margin of safety.