Given the current volatility investors face, it is more important than ever to identify high quality stocks over speculative ones with weak fundamentals. This means safe, profitable companies with strong balance sheets.
When it comes to investing, it pays over the long-term to buy and hold the best quality companies possible, because these elite stocks can resist competitive threats year-in, year-out, while competitors fail. This cycle of consistent outperformance and reinvestment can lead to incredible compounding returns.
In this article, I'm going to tell you what makes these stocks so special - let's take Relx (LON:REL) as an example. Relx is a conservative, large cap in the Professional Information Services industry.
How to spot moat indicators
Moats are desirable because they often guarantee a sustainable competitive advantage. But there are several ways that companies can get them. For example, they might have:
- Intangible Assets - Such as brands that customers love, valuable patents or regulatory approvals
- Switching Costs - It might be too costly, complicated or unnecessary for customers to look elsewhere
- Network Effects - When customers become part of a product it creates tremendously powerful businesses
- Cost Advantages - Superior processes and unique locations and assets make it hard for others to compete
- Great Scale - Large infrastructure and distribution networks are powerful barriers to entry in many industries
Has Relx (LON:REL) got a moat?
When it comes to searching for companies with moats, some of the biggest clues actually lie in their financial statements. By looking at a small number of important ratios you can get an idea about the competitive strength and profit power in a business.
Here's what they are and why they are important - and how Relx stacks up against them:
- High rates of Free Cash Flow - the measure of a thriving company.
- A high ratio of free cash flow to sales can be a very positive sign. For Relx, the figure is an impressive 21.7%.
- High Return on Capital Employed - the measure of a company growing efficiently and profitably.
- A 5-year average ROCE of more than 12 percent is a pointer to strong efficiency. For Relx, the figure is an eye-catching 23.0%.
- High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Relx has a 5-year average ROE of 57.0%.
- High Operating Margins (compared to peers) - the measure of a company with pricing power
- Relx has a 5-year average operating margin of 25.7%.
Some of the best quality stocks in the market have defensible models that can deliver high levels of shareholder returns over the long term. By analysing some key medium-term profitability and efficiency metrics, it's possible to start tracking them down. On this basis, it certainly appears that Relx has some of the financial traits of an economic moat.
To find out more you might want to take a look at the LON:REL StockReport from the award-winning research platform, Stockopedia. StockReports contain a goldmine of information in a single page and can help to inform your investment decisions.
To find more stocks like Relx, you'll need to equip yourself with professional-grade data and screening tools. This kind of information has traditionally been closely guarded by professional fund managers. But our team of financial analysts have carefully constructed this screen - Stockopedia’s Moats of the FTSE 350 - which gives you everything you need. So why not come and take a look?