One of the key things that Warren Buffett is said to look for when investing in a company is a sizeable economic moat. In other words, he is looking for some kind of competitive advantage that allows the company in question to charge higher prices, keep costs at a lower level, or else somehow maintain higher margins than its peers.
Brand Loyalty
Three examples of such companies are Diageo (LSE), Unilever (LSE: ULVR) and Reckitt Benckiser (LSE: RB), with all three stocks commanding a significant amount of brand loyalty from their customers. Indeed, all three companies produce products that can, in theory, be copied by their competitors, and yet they are all able to charge higher prices for their brands and maintain higher margins than competitors as a result.
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Strong Returns
This means that returns to shareholders are very strong, too. In fact, all three companies offer an excellent return on equity (ROE), with Diageo having a ROE of 32%, Unilever’s being 37% and Reckitt Benckiser’s being equally impressive at 28%. These figures show that the companies in question are highly profitable and are maximising the capital invested by investors to produce excellent returns.
Resilience
Furthermore, with demand for consumer goods, such as shampoo and headache tablets, and alcoholic beverages remaining highly resilient during even the most challenging recessions, Diageo, Unilever and Reckitt Benckiser each benefits from relatively stable demand for its products.
Certainly, they are unlikely to see a spike in demand during an upturn, and so may not keep up with their more cyclical index peers during the boom years, but they all offer sustainable, steady growth over the long run. For investors like Warren Buffett, this beats short, sharp bursts of growth hands down.
Valuation
As Warren Buffett declared many years ago, he’d rather buy a great business at a reasonable price than a reasonable business at a great price. So, given their superb brand portfolios and sizeable economic moats, neither Diageo, Unilever, nor Reckitt Benckiser trade at prices that could be deemed cheap.
Indeed, Diageo trades on a price to earnings (P/E) ratio of 18.9, while Unilever and Reckitt Benckiser have P/E ratios of 19.7 and 20 respectively. Although it may seem as though there is little scope for their ratios to rise, they have all been higher at times in the past. So, for any of the three stocks to command a P/E ratio of over 20 would not be a major surprise.
Looking Ahead
Clearly, growth potential for the three companies is centred on emerging markets. With demographics seemingly in their favour and all three companies having invested heavily in building their brands in the developing world, they appear to be well-placed to tap into the mid to high single digit growth rates that are on offer across the emerging world.
As a result of this potential, as well as their wide economic moats, high ROEs, long term resilience, and reasonable prices, Diageo, Unilever and Reckitt Benckiser could tempt Warren Buffett to make a move.
