Given the present disruption and volatility in the stock market, it is more important than ever 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 Harvey Norman Holdings (ASX:HVN) 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 Harvey Norman Holdings is showing the signs of having a profitable competitive edge - and the way to find that out is to look at its financials...
Has Harvey Norman Holdings (ASX:HVN) 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 Harvey Norman Holdings 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 Harvey Norman Holdings, the figure is an impressive 12.4%.
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 Harvey Norman Holdings, the figure is an eye-catching 15.1%.
High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Harvey Norman Holdings has a 5-year average ROE of 13.4%.
High Operating Margins (compared to peers) - the measure of a company with pricing power
- Harvey Norman Holdings has a 5-year average operating margin of 17.5%.
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 Harvey Norman Holdings has some of the financial traits of an economic moat.
To find out more you might want to take a look at the ASX:HVN 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 Harvey Norman Holdings, 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?