Why Games Workshop (LON:GAW) has a major competitive edge

It's probably fair to say that most of us would like to own shares in the most respected companies in the stock market... the ones that seem to be able to make consistently stunning profits over the long term.

What makes these elite stocks so appealing is they can resist competitive threats in order to generate breathtaking profits.

What makes them different is that they've got what billionaire investor Warren Buffett, calls economic moats. Like medieval castles, their profits are protected by unique characteristics.

In this article I'm going to tell you what makes these stocks so special - and I'm going to use Games Workshop as an example. You may be familiar with Games Workshop - it's an adventurous, mid cap in the Consumer Cyclicals 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 Games Workshop (LON:GAW) 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 Games Workshop 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 Games Workshop, the figure is an impressive 16.0%.   
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 Games Workshop, the figure is an eye-catching 45.5%.
3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
   - Games Workshop has a 5-year average ROE of 39.1%.
4. High Operating Margins (compared to peers) - the measure of a company with pricing power
   - Games Workshop has a 5-year average operating margin of 19.2%.

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 Games Workshop that you can find out about here.