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PROTECTING PROFITS: THE MAGIC OF ECONOMIC MOATS

By John Persinos • November 4, 2024 • Stocks to Watch

Printable PDF

Editor’s Note: What makes a company strongly competitive and resilient to
economic ups and downs? For insights I turned to Nathan Slaughter, chief
investment strategist of our premium trading service, High-Yield Investing.
That’s him, pictured below.

Nathan’s answer? In a word, “moats.” Just as moats were designed to protect
Medieval castles, they can turn a company into a financial fortress. In the
following interview, Nathan explains in detail and cites specific examples. My
questions are in bold.

--------------------------------------------------------------------------------

You’ve written extensively about the value of economic moats. What do you mean
by that term?

I place a great deal of importance on economic moats. So does Warren Buffett. In
the simplest terms, these are sustainable advantages that protect a business
from marauding competitors seeking to pillage its profits.

Without some type of moat, it’s nearly impossible for a company to sustain
superior returns on invested capital. All of the world’s most profitable
businesses have some type of moat, including such stalwarts as Apple (NSDQ:
AAPL), Amazon (NSDQ: AMZN), and Walmart (NYSE: WMT).

It’s an enviable position. Most industries have nothing to prevent new rivals
from crowding in and elbowing for space. Take fast-food chains for example. They
wage a never-ending battle for market share and must usually sacrifice profit
margins to attract and retain customers. The same is true of grocers, department
stores, and countless other cutthroat industries.

But with daunting barriers to entry, it’s difficult (if not impossible) for
newcomers to break in. So the market isn’t carved up into thin slices. The
entire heaping pie is served up to one or two lucky incumbents.

Please amplify the topic of “barriers to entry.”

There are different types of moats, barriers to entry being only one of them.
There are several different barriers that help dissuade would-be competitors
from setting up shop. Let’s discuss four of the most common deterrents.

Regulatory hurdles. Some industries are governed by layers of rules, regulations
and oversight that scare away potential players. Slot machine makers, for
example, must get the blessing of gaming control boards and other regulatory
bodies before they can even think of putting a product on the market.

In some cases, the powers-that-be go out of their way to limit the playing
field. The credit ratings business is a textbook example. Stringent SEC
qualifications make it nearly impossible to get a toe-hold in this industry, so
a handful of lucky firms like Moody’s (NYSE: MCO) rake in all the profit.

Even garbage dumps can be a bonanza for investors. Waste must be hauled away
somewhere, but nobody wants a new landfill in their backyard. Securing necessary
permits, environmental zoning variances, and operating licenses can be a
nightmare. That makes existing sites quite valuable.

Waste Management (NYSE: WM) owns more than 250 permitted landfills across the
country. And with stout regulatory roadblocks to new ones, the company has few
large-scale competitors. It even collects “tipping fees” from smaller regional
players that use one of its sites.

Capital requirements. Anybody with a few thousand dollars and decent skills in
the kitchen can open up a new diner. That’s why they are found on every street
corner. But some industries require hundreds of millions, or even billions, just
to get in the game. For example, building a state-of-the-art semiconductor
manufacturing facility doesn’t come cheap.

Patents and licenses. Researching, developing, and ultimately commercializing a
new product can be expensive and time-consuming. But if that product is awarded
a patent, the government itself is putting up a “keep out” sign to would-be
rivals.

An obvious example involves biotech drugs. AbbVie’s (NYSE: ABBV) Humira, which
is used to treat arthritis and other auto-immune disorders, rakes in billions in
annual sales. It will be years before protective U.S. patents expire and generic
competition is introduced.

Then there are tech companies like Qualcomm (NSDQ: QCOM), whose breakthroughs in
the early 2000s are still generating royalty income from the sale of most mobile
phones worldwide.

Contracts, concessions, and other agreements. Municipal, state, and federal
governments often privatize certain functions or otherwise grant a limited
number of permits to conduct operations. Those lucky enough to win one of these
coveted concessions can milk them for years to come, often free of competition.

Case in point, there are hundreds of general aviation (i.e. private and charter
plane) airports across the country such as Fort Lauderdale Executive and North
Las Vegas. Refueling and concierge services are often handed to a single vendor,
called a fixed-base operator. That’s a bit like operating the only gas station
in town.

What other types of companies benefit from economic moats?

Power utilities and railroad owners. The latter benefit from routes that are
protected by right-of-way permits.

Defense firms represent another sector that enjoys barriers to entry. For
example, there are only six shipyards capable of building vessels for the U.S.
Navy, and defense contractor General Dynamics (NYSE: GD) owns three of them.
General Dynamics has been the primary builder of submarines for the Navy for
more than 100 years.

WATCH THIS VIDEO: How to Thrive in Retirement

The manufacture of complex weapons systems such as combat jets and nuclear
submarines requires enormous capital, economies of scale, and engineering
expertise. Defense companies also benefit from security clearances and
hard-to-achieve access to government contacts. Long-term relationships with
Pentagon officials aren’t something an upstart competitor can quickly replicate.

Thanks for your time.

PS: Quite a few of Nathan Slaughter’s investment recommendations over the years
have benefited from barriers to entry. That includes drug companies, power and
gas utilities, and railroad owners (whose routes are protected by right-of-way
permits), among others.



Nathan’s subscribers over at his premium investment advisory High-Yield
Investing have been using stocks like this to build a powerful portfolio that
throws off thousands of dollars in extra income each month. And it’s not too
late for you to get started.

Nathan has just put together a special report called “Monthly Money-Makers,” and
it’s your blueprint for retirement security. This report pinpoints income stocks
that pay out generous dividends…every 30 days. Want to tap a steady stream of
monthly income? Click here now.

--------------------------------------------------------------------------------

John Persinos is the editorial director of Investing Daily.

Subscribe to John’s video channel:

 


ABOUT THE AUTHOR

John Persinos
Bio | Archive
John Persinos is the editorial director of Investing Daily, overseeing such
publications as Personal Finance, Utility Forecaster, Profit Catalyst Alert,
Rapier's Income Accelerator, Income Forecaster, and Marijuana Investing Daily,
among others. John also writes the Mind Over Markets daily stock market recap,
and he's the chief investment strategist of Marijuana Profit Alert.

 
John has decades of experience in the technology and political realms. He has
worked as a staff editor at Inc. and Venture magazines, and written for
Kiplinger's, Street Authority, Investing Answers, and TheStreet.com, to name a
few. In a career that has spanned more than 40 years, John has been diligently
and prolifically covering the news and its impact on investors.

 
John also has experience with the inner-workings of Capitol Hill, serving as a
press secretary to U.S. Rep. Byron Dorgan (D-ND). John started his career as a
daily newspaperman with The Orlando Sentinel.

 
John holds undergraduate and graduate degrees from Boston University. He also
completed the Davenport Fellowship in Business and Economics Reporting at the
University of Missouri (Columbia).

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