When it comes to investing, I'm convinced it pays to buy and hold the best quality companies possible. These companies can compound investment returns at consistently above-average rates over the long term.
These stocks are different because they've got what billionaire investor Warren Buffett, calls economic moats.
In this article, I'm going to tell you what makes these stocks so special by using Rio Tinto (LON:RIO) as an example. Rio Tinto is a adventurous, large cap in the Integrated Mining industry.
Has Rio Tinto (LON:RIO) got a 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 Rio Tinto 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 Rio Tinto, the figure is an impressive 15.8%. - 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 Rio Tinto, the figure is an eye-catching 12.7%. - High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
- Rio Tinto has a 5-year average ROE of 15.4%. - High Operating Margins (compared to peers) - the measure of a company with pricing power
- Rio Tinto has a 5-year average operating margin of 26.5%.
So it does seem as though Rio Tinto might have some kind of economic moat. A quick look at Rio Tinto's (LON:RIO) StockReport page shows that the company has a Quality Rank of 91.
Next steps
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 Rio Tinto has some of the financial traits of an economic moat.
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.