The best companies resist competitive threats year after year, while their competitors fail. This cycle of constant outperformance and reinvestment can lead to incredible compounding returns, especially during times of global economic uncertainty.

What makes these companies different is that they have what billionaire investor Warren Buffett calls economic moat.

Defensive moats allow companies to generate outsized profits over long periods of time. They can be an investment goldmine. And while these stocks may be hard to come by, there are signs that Tatton Asset Management (LON:TAM) may be one of them.

Before we start explaining why it looks like a high-quality business, here are some of the main ways a business can build a strong moat around itself:

• Large scale – Composed of large infrastructures and distribution networks
• Intangible assets – Such as trademarks, patents or regulatory approvals
• Network effects – When customers are part of a product
• Cost advantages – Achieved through superior processes and unique locations and assets
• Change costs – It may be too expensive or complicated for customers to leave

Economic swing of Tatton Asset Management (LON:TAM)

When it comes to researching companies with moats, some of the biggest clues are actually found in their financial statements. By examining a small number of important ratios, you can get an idea of ​​a company’s competitive strength and profit capacity.

Here’s what they are and why they’re important – and how Tatton Asset Management stands against them:

1. High free cash flow rates – the measure of a successful business.
   – A high ratio of free cash flow to turnover can be a very positive sign. For Tatton Asset Management, the figure is an impressive 45.5%.
2. High return on capital employed – the measure of an efficient and profitable growing business.
   – An average ROCE over 5 years of more than 12% is an indicator of strong efficiency. For Tatton Asset Management, the figure is an impressive 37.0%.
3. High return on equity (compared to its peers) – the measure of a company making good profits on its assets.
   – Tatton Asset Management has an average ROE over 5 years of 35.2%.
4. High operating margins (compared to its peers) – the measure of a company with pricing power
   – Tatton Asset Management posted an average operating margin over 5 years of 35.4%.

What does this mean for potential investors?

Some of the highest quality stocks on the market have defensible models that can deliver high levels of shareholder return over the long term. But there are no guarantees and it is important to do your own research. Indeed, we have identified some areas of concern with Tatton Asset Management which you can read about here.