Warren Buffett makes it sound so easy: find high-quality companies, wait for a good price to buy, and then hold them forever. Some of these high-quality companies are famous and rarely offer good entry points for investors.
Others, though, are less well-known and have the same ability to resist competitive threats and generate breathtaking profits year after year. These economic moats, which allow the company to compound returns at above-average rates over the long term, might not be priced into the share price.
Let's take Professional & Commercial Services company Relx (LON:REL) as an example.
The telltale signs of an economic moat
There are several ways that companies can build economic moats. For example, they might have:
- Intangible Assets - Such as brands, patents or regulatory approvals
- Switching Costs - It might be too costly or complicated for customers to leave
- Network Effects - When customers become part of a product
- Cost Advantages - Gained through superior processes and unique locations and assets
- Great Scale - Comprised of large infrastructure and distribution networks
So, does Relx (LON:REL) have a moat?
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 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.
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