Four reasons why Hargreaves Lansdown PLC (LON:HL.) has a moat around it

When it comes to investing, most of us love the idea of owning shares in the best quality companies around. I'm talking about some of the market's most respected names... the ones you'd be happy to tuck away and keep for the long-term. 

What makes these elite stocks so appealing is their ability to resist competitive threats and generate breathtaking profits. They compound investment returns at consistently above-average rates over long periods.

These stocks are different because the've got what billionaire investor Warren Buffett, calls economic moats. Like medieval castles, their profits are fortified by impregnable business models.

In this article I'm going to tell you what makes these stocks so special - and I'm going to use Hargreaves Lansdown (LON:HL.) as an example. Hargreaves Lansdown is a balanced, large cap in the Investment Management & Fund Operators industry.  

How can you tell whether a company has a moat?

Moats are desirable because they often guarantee a sustainable competitive advantage. But there are several ways that companies can get them. For example, they might have:

• 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

Has Hargreaves Lansdown (LON:HL.) got a moat?

When it comes to searching for companies with moats, some of the biggest clues actually lie in their financial statements. By looking looking at a small number of important ratios you can get an idea about the competitive strength and profit power in a business.

Here's what they are and why they are important - and how Hargreaves Lansdown 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 Hargreaves Lansdown, the figure is an impressive 50.6%.   
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 Hargreaves Lansdown, the figure is much higher than that, at 83.4%.
3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
   - Hargreaves Lansdown has a 5-year average ROE of 71.6%.
4. High Operating Margins (compared to peers) - the measure of a company with pricing power
   - Hargreaves Lansdown has a 5-year average operating margin of 59.5%.  

What does this mean for potential investors?

Some of the best quality stocks in the market have defensible models that can deliver high levels of shareholder returns over the long term. But there are no guarantees and it's important to do your own research. Indeed, we've identified some areas of concern with Hargreaves Lansdown that you can find out about here.