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Given the ongoing geopolitical and economic uncertainty, it is more important than ever to know how to identify high quality stocks for your portfolio. That means knowing how to find highly profitable companies that are able to fend off competitive threats over the long term.
These sorts of stocks are different because they've got what billionaire investor Warren Buffett calls economic moats.
Defensive moats let companies compound returns at above-average rates over long periods. They can be an investment goldmine. And while these stocks can be hard to find, there are signs that Check Point Software Technologies (NSQ:CHKP) might be one of them.
Before we get started on why this looks like a high quality business, here are some of the main ways that a company can build a strong moat around itself:
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
So the question is whether Check Point Software Technologies is showing the signs of having a profitable competitive edge - and the way to find that out is to look at its financials...
Has Check Point Software Technologies (NSQ:CHKP) got a moat?
Some of the biggest indicators of a moat involve persistent strong margins and high levels of cash generation – cash being very important given the uncertainty about the economy. Here are a few ways of gauging these characteristics - and how Check Point Software Technologies compares:
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 Check Point Software Technologies, the figure is an impressive 52.5%.
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 Check Point Software Technologies, the figure is an eye-catching 21.0%.
High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Check Point Software Technologies has a 5-year average ROE of 23.2%.
High Operating Margins (compared to peers) - the measure of a company with pricing power
- Check Point Software Technologies has a 5-year average operating margin of 45.5%.
What does this mean for potential investors?
Some of the best quality stocks in the market have defensible models that can deliver high levels of shareholder returns over the long term. But there are no guarantees and it's important to do your own research. Indeed, we've identified some areas of concern with Check Point Software Technologies that you can find out about here.