What is the Pit, the term Warren Buffett refers to?

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There are different profiles when making an investment. A more risky profile that pursues greater benefits, to more conservative profiles minimizing the risks to the maximum without opting for such a large benefit. Warren buffett, with followers all over the world, including myself, coined the term moat. Moat in English comes from moat, a parallel that Buffett made with moats in castles. It is one of the aspects, or set of aspects, that you take into account when investing in a company. Cuanto más grande be el Foso, más inamovible será la posición que ocupará el negocio.

The Moat is not itself a predictor, but it is a sign of stability that enables you to be more confident when buying stocks. Often when investing, you can make rational decisions, but unconsciously they are impulsive. Sometimes due to the arguments of a company, due to the appreciation of some shares, others due to falling expectations, etc. The Pit enables you to have that common sense, that broad vision to see what place a company truly occupies. The market is very wide and a selection of companies with Moat, have proven to be resistant to periods of recession, and with more relaxed price declines.

What is a company with Moat (moat)?

The economic moat or the economic moat, according to Buffet, refers to the competitive advantages of a company compared to its competition. In the same way, the sustainability of that product or service and also its sustainability, the prolongation in time. The bigger those competitive advantages, the bigger Pit we'll talk about.

A company that develops an excellent product that is attractive to consumers and also profitable does not take long to attract competitors. Other companies that want to replicate the product and even improve it, cause it to lose market share. Those more distributed benefits are the main drawback that the company that has developed the novel product will have to face.

However, there are many of these companies that are capable of surviving these phenomena. These companies usually have a good pit, economic structures that make them able to resist before the other "copycats." These types of companies, with large economic trenches, are capable of generating value in the coming years. Next, we will see what distinguishes these companies that make them so profitable.

What determines that a company has a good moat?

There are several alternatives for examining how wide and / or deep a company pit is. Over time, therefore, there have been some shared characteristics in determining it. Among them, the most relevant that could be found are the following:

1. Low business costs. First of all for its easy understanding. Companies capable of producing the same good or service, but at a lower cost they have a lot of advantage. En caso de tener estatus como marca, pueden igualar el precio de la competencia y conseguir mayores márgenes de beneficio. Si la strategy es comercializar a un precio más bajo, pueden desbancar más fácilmente a las otras marcas.
2. Intangible assets. We would frame within this criterion those non-physical and immaterial things that report a strong advantage for the company. Patents, licenses and even the brand itself of the business. An example of patents can be found with various pharmaceutical companies. When they get a good result after passing the different phases, and they can start selling a new drug, and they have this exclusivity. Another example, that of technology companies. In terms of licenses, as an example, we could find mineral extractors, who have the license to exploit a certain area. And in conclusion, in terms of brand, a good example would be Harley Davidson, whose brand has such a strong power over some consumers that some even get their name tattooed.
3. Due to existing demand (Red Effect). The product or service can become so popular that prices can begin to rise gradually, without affecting new consumers. Happens when a company gains market share, y se vuelve tan grande que inclusive atrae a nuevos clientes motivados por otros consumidores que ya están allí. Un buen ejemplo sería Amazon en vinculación a las ventas online. Amazon no solo distribuye, sino que muchos vendedores recurren de forma directa a él debido a que la compañía ya tiene un gran nicho de mercado.
4. Replacement costs. Cambiar la compañía en la que se encuentra a veces puede tener costos no deseados. A modo de ejemplo, no cambiamos de banco tan rápido como ir a cualquier supermercado, a menos que la oferta que nos ofrezcan sea verdaderamente atractiva. Del mismo modo, no vamos a cambiar todo el software de una compañía, debido a que otro programa es algo más atractivo para nosotros. Que power to guarantee clients due to the costs involved in changing companies, is another feature of Moat.

How to take advantage of the Pit?

A company with Moat has a higher intrinsic value than its competitors. One of the alternatives to obtain benefits is to invest in them. The question as always is to know when is the time.

The market tends to have economic cycles, periods of expansion and others of contraction. However, and what it does very frequently, is to create much higher expectations in certain companies compared to the rest. It should be logical then that for a company with Moat the market value would have the economic moat that the company has. However, it does not happen as often. This phenomenon may be due to the fact that developing a good pit takes, according to experts, 10 years or more. On the other hand, after all this time, and despite being constant companies in their growth, the time factor also influences. Finally this results in a homogeneity of quotes and securities between listed companies.

Pay attention that two companies in the same sector where one of them has a higher Moat than the other, helps to establish with more precision which is the best option to invest. In this type of investment, short routes are not sought, but long-term oriented. At the end "the waters return to their course", which theoretically will bring (if there are no eventual events that harm it) benefits and without major shocks.

As Buffett himself put it, "only when the tide goes out do you know who was swimming naked."