Is there a competitive moat at Paypoint (LON:PAY)?

Companies that are both hugely profitable and difficult to compete against carry elite status in the stock market. These firms have what Warren Buffett describes as deep and wide protective moats - and they're the stocks that investors like you and I would love to own.

What marks these these companies out is their ability to generate outsize profits over long periods. By doing that, they can compound investment returns at incredible rates.

In this article I'm going to tell you what makes these stocks so special - and I'm going to use Paypoint as an example. You may be familiar with Paypoint - it's a balanced, mid cap in the Industrials sector.

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 Paypoint (LON:PAY) 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 Paypoint 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 Paypoint, the figure is an impressive 28.3%.
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 Paypoint, the figure is an eye-catching 54.6%.
3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
   - Paypoint has a 5-year average ROE of 41.2%.
4. High Operating Margins (compared to peers) - the measure of a company with pricing power
   - Paypoint has a 5-year average operating margin of 20.8%.

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 PayPoint that you can find out about here.