We can define moats as competitive advantage of a company. What does this really mean? Basically to have a better business position than competitors.
This will allow the business to maintain and increase its profit margin and market share.
Warren Buffett once stated that the company itself can be seen as the equivalent of a castle and the value of the castle will be determined by the strength of the moat. In other words: the moat protects those inside the castle and prevents outsiders from entering the fortress.
How do you know your little company has a moat?, how you can measure it?
From financial point of view is quite simple. your company generate excess economic returns for a long period of time.
And this can measure wtih two factors:
1/ Your company has a Return On Invested Capital (ROIC) greater than its Weighted Average Cost of Capital (WACC)
2/ The ROIC has maintained high and constant for a reasonable period of time in the past (in listed companies is considered to be 15 years).
Looking at the evolution of the gross margin and ROIC over the past decade can already give you a great indication. When both metrics are robust and (very) high, this is already a great sign that the company has a moat
kinds of moats
In general, there are 5 different kinds of moats:
- Switching costs
- Intangible assets
- Network effects
- Cost advantages
- Efficient scale
This post can help you to go more in depth about the types of moats.