The best calibre of companies resist competitive threats year-in, year-out, while their competitors fail. This cycle of consistent outperformance and reinvestment can lead to incredible compounding returns – especially in times of worldwide economic uncertainty.
What makes these companies different is that they've got what billionaire investor Warren Buffett, calls economic moats.
Defensive moats let companies generate outsize profits over long periods. They can be an investment goldmine. And while these stocks can be hard to find, there are signs that Relx (LON:REL) 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:
Great Scale - Comprised of large infrastructure and distribution networks
Intangible Assets - Such as brands, patents or regulatory approvals
Network Effects - When customers become part of a product
Cost Advantages - Gained through superior processes and unique locations and assets
Switching Costs - It might be too costly or complicated for customers to leave
Relx (LON:REL)'s economic 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?