Economic uncertainty and market volatility have shown once again why it's vital to have high quality stocks in your portfolio. Safe, profitable companies with strong balance sheets can offer solid returns over the long term, even in a crisis.
The best quality companies are often some of the market's most respected names... but there are others that you might not have heard of. What makes them stand out is their ability to resist competitive threats and generate breathtaking profits. They compound investment returns at consistently above-average rates over time.
These stocks have got what billionaire investor Warren Buffett, calls economic moats. Like medieval castles, their profits are fortified by impregnable business models.
Here's a quick explainer on what makes these stocks so special - using Jarvis Securities (LON:JIM) as an example.
Signs of strength
First of all, here are some of the ways that companies actually establish these very profitable competitive moats:
- 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
When it comes to finding companies with moats, some of the biggest clues actually lie in their financial statements. Here's what they are and why they are important - and how Jarvis Securities 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 Jarvis Securities, the figure is an impressive 24.6%. - 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 Jarvis Securities, the figure is an eye-catching 77.5%. - High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Jarvis Securities has a 5-year average ROE of 63.8%. - High Operating Margins (compared to peers) - the measure of a company with pricing power
- Jarvis Securities has a 5-year average operating margin of 44.8%.
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.