Four signs of a competitive moat at Tata Consultancy Services (NSI:TCS)

Four signs of a competitive moat at Tata Consultancy Services (NSI:TCS)

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Given widespread uncertainty in the stock market for the rest of 2020, it is more important than ever to identify high quality stocks for your portfolio. This means safe, profitable companies with strong balance sheets.

Most investors would agree that the best quality companies in the stock market often make the best investments as well. I'm talking about some of the most respected names... the ones that seem to be able to make consistently stunning profits over the long term.

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

These stocks are different because they'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 Tata Consultancy Services (NSI:TCS) as an example. Tata Consultancy Services is a balanced, large cap in the IT Services & Consulting 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 Tata Consultancy Services (NSI:TCS) 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 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 Tata Consultancy Services 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 Tata Consultancy Services, the figure is an impressive 18.6%. 
  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 Tata Consultancy Services, the figure is an eye-catching 37.9%.
  3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
    - Tata Consultancy Services has a 5-year average ROE of 35.0%.
  4. High Operating Margins (compared to peers) - the measure of a company with pricing power
    - Tata Consultancy Services has a 5-year average operating margin of 25.4%.

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 Tata Consultancy Services that you can find out about here.


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