Four Clues To The Quality Of London Stock Exchange

Four Clues To The Quality Of London Stock Exchange

Ben Hobson  | Jun 05, 2020 11:18

Warren Buffett makes it look so easy: find high-quality companies, wait for a fair price to buy, and then hold them... forever. The problem of course is that these stocks are hard to find - but there are signs that London Stock Exchange Group PLC (LON:LSE) could be one of them.

Given uncertainty in the stock market caused by Coronavirus, it is more important than ever to find high quality stocks. That means buying safe, profitable companies with strong balance sheets. They're the kind of stocks that have the ability to resist competitive threats and generate breathtaking profits year after year. To do that, they need what Buffett describes as "an economic moat".

Defensive economic moats let companies compound returns at above-average rates over long periods. Here's a rundown on what makes these stocks so special - using London Stock Exchange, which is active in the Investment Banking & Investment Services industry, as an example.

Signs of strength

There are several ways that businesses can make themselves very hard to compete with, including:

  • 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 London Stock Exchange stacks up against them:

  1. 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 London Stock Exchange, the figure is an impressive 27.7%.
  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 London Stock Exchange, the figure is an eye-catching 10.3%.
  3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
    - London Stock Exchange has a 5-year average ROE of 11.3%.
  4. High Operating Margins (compared to peers) - the measure of a company with pricing power
    - London Stock Exchange has a 5-year average operating margin of 30.5%.

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.

Original Post

Ben Hobson

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