“In business, I look for economic castles protected by unbreachable moats.”

Warren Buffett is a huge advocate of companies that can boast a sustainable competitive advantage. His annual letters to shareholders are peppered with references to investments that generate high levels of sustainable returns because of their brand power, cost advantages and scale. Apply these rules to the FTSE 100 and you find names like British American Tobacco, Reckitt Benckiser and Burberry. Blue chips like these are likely to continue driving mighty returns from the likes of cigarettes, household products and fashion.

While truly sustainable moats generally aren’t found in smaller companies, there is no reason not to set the benchmark high in the search for quality. Indeed, looking for signs of a moat could be a useful first step in finding where long-term profitable returns really lie in a market like AIM.

How to find a moat

The hallmarks of an economic moat are varied - Ed wrote a detailed article about it here - but in screening terms there are signals that offer clues to finding one. These stocks typically command high operating margins and generate high levels of free cash flow (which can be invested). Those investments themselves produce strong returns, which can be seen in measures like return on capital employed (ROCE) and return on assets (ROA).

A useful additional check is Stockopedia’s QualityRank. This takes into account these long-term quality factors but also includes balance sheet strength and any potential accounting or insolvency risk red flags. These are useful in spotting the signs that a moat may be narrowing or drying up altogether. Using these rules, we screened AIM for companies that are showing the signs of an sustainable competitive edge. Stockopedia subscribers can see the full screen results here.  

What we’re seeing right now

Topping the list is Abcam (LON:ABC), a company that produces and sources high grade antibodies used in scientific research. When it floated in 2005, Abcam reported sales of £12.1 million and profits of £2.98 million. Last year those figures had grown to £122.2 million and £32.7 million respectively. This company throws off cash from its very profitable - and growing - online catalogue of antibodies that are sold to a loyal customer base. Over the past five years it has produced an average ROCE of 35.8% while operating…

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