Invesco Canada blog

Insights, commentary and investing expertise

Michael Hatcher | January 21, 2013

The moat around the castle

When we’re looking at a company, one of the key qualities we look for is competitive advantage.  I want to see a moat around the castle.

Our goal as investors is to seek out quality companies at great prices. And for me, true quality is a business with high returns on invested capital and high levels of free-cash flow conversion.  Quite often, companies with these attributes have a strong competitive advantage or barrier to entry – something that stops others from competing against them.  

When a company is able to generate high returns on capital for long periods of time, it stands to reason that other people would love to launch a similar business.  Unless there is a reason they can’t.

A barrier to entry can take any number of forms. Here are a couple of examples (both companies that are currently in one or more Trimark portfolios):

Diageo PLC*

Diageo is the world’s largest spirits manufacturer, based in the U.K. You might not know the company name, but you likely know some of its biggest brands: Smirnoff, Johnnie Walker, Baileys, Guinness, Crown Royal.

So, where are the barriers to entry for a spirits company?  Well, 40% of Diageo’s profit comes from scotch – a product that needs to be distilled for a minimum of 3 years and many products over 12 years.  Diageo has the largest portfolio of maturing Scotch stocks in the world – valued at just under £2 billion.  A new competitor would need to invest significant capital and…wait 3 to 12 years to find out if they have a consumable product.  This is the type of moat, deep and wide, that we like to see.

Experian PLC*

Our on-the-ground research led us to Experian, a credit reporting firm that we believe was oversold because of negative investor sentiment around financials in general. Why do we believe this is a stable business with real growth prospects?

One of the key elements of our thesis is the existing barriers to entry.  A credit bureau is essentially a clearing house for customer and business credit information.  When people are leasing a new car, getting a credit card or applying for a mortgage, credit checks are done through these bureaus.  Over time, Experian has built a huge proprietary database of credit information that is very, very difficult to replicate – a powerful barrier for others considering this type of business.  In many regions the industry is dominated by only two players. In Brazil, Experian alone dominates.

This is a company that we like because it provides us with exposure to the financials sector, while avoiding some of the turmoil that comes along with investing in the big banks and insurers – balance sheet concerns and proposed regulatory changes that may have a negative effect on future profits, to name only two.  And on top of that, Experian has an unbelievably wide moat, requires little capital and generates significant free cash.

The chart below (click to enlarge) uses Experian to demonstrate the value of buying strong businesses, as opposed to sector-based investing.

Experian and Diageo have both been long-term holdings in various Trimark portfolios. Experian was added to Trimark Fund in Q2, 2012 and continues to be a core holding.

*The above companies were selected for illustrative purposes only and are not intended to convey specific investment advice.

Get more information on Trimark Fund.
Learn more about the Trimark Investments team.
Trimark Fund, Series A provided the following performance returns as at November 30, 2012: 1-year, 10.09%; 3-year, 6.19%; 5-year, -1.83%; 10-year, 1.84%.

Subscribe to the blog

Subscribe to receive notifications for: *


Do you want to subscribe in French?

Subscribe to receive e-mails from Invesco Canada Ltd. about this blog. To unsubscribe, please e-mail blog@invesco.ca or contact us.

2 responses to “The moat around the castle

  1. This is a good example of explaining your investment process and is something worth explaining to advisors regularly using real examples. For top 10 holdings you might even consider adding a super-short summary of the thesis for each with categories such as:
    – what initially attracted our attention
    – where is the margin of safety
    – the moat
    – how we will make money on this company

    1. Thanks for your comment Dave. We aim to provide specific examples when discussing aspects of our investing style and I appreciate knowing that this type of summary is valuable to you as an advisor.

Leave a reply

Your email address will not be published. Required fields are marked *