Finding companies with sustainable competitive advantages, or “wide moats” can be key for compounding returns over time. Just like the moats that surrounded medieval castles to protect them from invaders, an economic moat protects a company’s profits and market share from competitors. Legendary investor Warren Buffett has built his immense fortune by focusing on wide moat companies.
There are several major sources of moats including:
- Intangible Assets like strong brand names, patents or regulatory licenses
- High Switching Costs that make it expensive or inconvenient for customers to stop using a company’s products
- Network Effects that make a service more valuable as more people use it
- Cost Advantages stemming from superior processes, unique assets or large scale
- Efficient Scale in a niche market that can only support one or a few competitors
Characteristics of Wide Moat Companies
Some of the telltale signs of a wide moat company include:
- Consistent profitability throughout the economic cycle
- High returns on capital thanks to strong pricing power and a loyal customer base
- Steadily increasing earnings and free cash flow over many years
- Little need for external capital to fund growth
- Meaningful “insider ownership” by management whose interests are aligned with shareholders
Buffett himself looks for companies with a long history of consistent earnings growth, aiming for at least a decade of reliable profits. He also seeks out firms that generate returns on equity and total capital well in excess of 15% on a sustained basis. These quantitative markers are strong evidence of a defensible moat.
5 Wide Moat Stocks Scoring Highly on Validea’s Models
Our investment models are based on the published writings of some of history’s greatest investors, including Warren Buffett. Here are five stocks that currently earn top scores for their wide moats and outstanding fundamentals:
- Apple Inc (AAPL): This iconic maker of iPhones, Mac computers and other beloved gadgets earns a perfect 100% score from our Buffett-based model. Apple’s powerful brand, high switching costs and network effects form a deep and wide moat around its business. The company has grown EPS at a 15.7% annualized rate over the past decade while generating an astounding 164% average return on equity over the past three years.
- Tractor Supply Co (TSCO): This leading retailer of home improvement and agriculture products in rural markets scores 93% from our Buffett model. Tractor Supply’s strong brand, unique merchandise mix and prime store locations give it a wide moat in its niche. The firm has increased EPS in each of the past 10 years, delivering a 15.8% annualized growth rate. Returns on equity have averaged over 37% in the past decade.
- Alphabet Inc (GOOGL): The parent company of Google is another Buffett model favorite with a 100% score. Google’s moat springs from the network effects powering its search and advertising business along with intangible assets like patents and user data. Alphabet has compounded EPS at a 19.8% rate over 10 years with returns on equity averaging 25% over the past three years.
- Mastercard Inc (MA): This payments technology titan earns an 86% score from the Buffett approach. Mastercard benefits from powerful network effects—its platform becomes more valuable to merchants and consumers as it grows. This wide moat has enabled Mastercard to increase EPS by 16.5% per year over the past decade with an incredible 144% average ROE over the last three years.
- Applied Materials, Inc. (AMAT): The world’s largest semiconductor equipment maker also scores a perfect 100% from our Buffett model. Applied Materials’ wide moat stems from its intangible assets, high customer switching costs and scale advantages in a consolidated industry. The company has grown EPS by 24% annually over 10 years while generating average ROE of 46% over the past three years.
The Bottom Line on Wide Moat Stocks
Focusing your portfolio on companies with wide moats is a proven path to long-term investment success. By digging moats, these firms are able to keep competitors at bay and generate above-average growth and profitability over many years. Just be sure to diversify your holdings across different moat types and industries.
Further Research
