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 Hennessy Advisors Inc (NAQ:HNNA) 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 Hennessy Advisors Inc is showing the signs of having a profitable competitive edge - and the way to find that out is to look at its financials...
Has Hennessy Advisors Inc (NAQ:HNNA) 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 Hennessy Advisors Inc 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 Hennessy Advisors Inc, the figure is an impressive 31.3%.
- 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 Hennessy Advisors Inc, the figure is an eye-catching 26.8%.
- High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Hennessy Advisors Inc has a 5-year average ROE of 34.8%.
- High Operating Margins (compared to peers) - the measure of a company with pricing power
- Hennessy Advisors Inc has a 5-year average operating margin of 43.8%.
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 Hennessy Advisors Inc that you can find out about here.
Alternatively, if you'd like to find more shares that have some of the characteristics of promising economic moats, you should take a look at this Economic Moats screen.