Does A2 Milk (ASX:A2M) have an economic moat?Fri 11:19am by Ben HobsonMost investors would agree that it pays to buy and hold the best quality companies possible. I'm talking about some of the market's most respected names... that ones we'd all like to hold for the long-term. What makes these elite stocks so appealing is their ability to resist competitive threats and generate breathtaking profits. They compound investment returns at consistently above-average rates for long periods.These stocks are different because the've got what billionaire investor Warren Buffett, calls economic moats. Like medieval castles, their profits are fortified by impregnable business models.In this article I'm going to tell you what makes these stocks so special - and I'm going to use A2 Milk (ASX:A2M) as an example. A2 Milk is an adventurous, large cap in the Food Processingindustry. GET MORE DATA-DRIVEN INSIGHTS INTO ASX:A2M »How can you tell whether a company has a moat?Moats are desirable because they often guarantee a sustainable competitive advantage. But there are several ways that companies can get them. For example, they might have:Intangible Assets - Such as brands that customers love, valuable patents or regulatory approvalsSwitching Costs - It might be too costly, complicated or unnecessary for customers to look elsewhereNetwork Effects - When customers become part of a product it creates tremendously powerful businessesCost Advantages - Superior processes and unique locations and assets make it hard for others to competeGreat Scale - Large infrastructure and distribution networks are powerful barriers to entry in many industriesHas A2 Milk (ASX:A2M) 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 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 A2 Milk 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 A2 Milk, the figure is an impressive 20.2%. 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 A2 Milk, the figure is an eye-catching 30.7%.High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.- A2 Milk has a 5-year average ROE of 25.1%.High Operating Margins (compared to peers) - the measure of a company with pricing power- A2 Milk has a 5-year average operating margin of 14.7%. If you want to find more Australian companies with these kinds of attractive moat-like traits, you can try out this pre-set screen.Next stepsSome 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 A2 Milk has some of the financial traits of an economic moat.To find out more you might want to take a look at the A2 Milk 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 A2 Milk, 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?
A2M Price at posting:
$13.40 Sentiment: Buy Disclosure: Held
(20min delay)
