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All Contents © 2017The Kiplinger Washington Editors
By Daren Fonda, Senior Associate Editor
| February 2016
Investing for more than 50 years, Warren Buffett has made a fortune on everything from bank stocks to shares of a Chinese battery maker. But if there’s one thing he always looks for, it’s businesses with a so-called wide economic moat.
Whatever the industry, companies that prosper over the long term tend to have defenses around their business that protect their profits and shield them from competitors. These barricades could be the advantage of low costs, a dominant brand or service, or steep barriers to entering a business—anything that helps a company maintain its financial edge and keep profits afloat.
Of course, few moats are permanently impregnable, making it critical to find companies with sustainable, long-term advantages. If a business constantly needs to reinvent itself to survive, or if it operates in an industry that’s deteriorating (think coal and some other commodities), a moat may offer scant protection. As Buffett puts it, “A moat that must be continually rebuilt will eventually be no moat at all.”
Today, investing in fortress-like companies seems prudent. While these defenses can't protect them from all economic downdrafts or a broad stock-market decline, wide-moat companies, including our seven picks, should be more stable and suffer less collateral damage than weaker rivals.
All returns, share prices and related data are as of January 22; price-earnings ratios are based on estimated earnings for the next four quarters.
52-week range: $503.48-$798.69
Market capitalization: $512.7 billion
Annual sales: $86.1 billion
Estimated 2015 earnings per share: $28.99
Estimated 2016 earnings per share: $34.25
Price-earnings ratio: 22
Google’s parent company, Alphabet (GOOGL, $745.46), now includes everything from self-driving cars to “smart home” energy products. At its core, though, Alphabet has erected a fortress around two giant parts of the tech world: mobile devices and digital advertising. Despite stiff competition, Alphabet has tightened its grip in these areas. Launched in 2007, its Android operating system now powers an astounding 85% of mobile devices around the world, creating a platform for Google to sell more ads, map services and apps. Google is also winning the race for digital ads, taking an estimated 54 cents of every search-related ad dollar in 2015 and nearly 13% of digital ads in total, according to research firm eMarketer.
One of the FANGs—along with Facebook (FB), Amazon.com (AMZN) and Netflix (NFLX)—that led the stock market in 2015, shares of Alphabet (nee Google) have gained 39% over the past year. Analysts see the company earning $34.25 per share in 2016, up 18% from 2015. The stock trades at 22 times that estimate, a reasonable price-earnings ratio relative to expected earnings growth.
SEE ALSO: What Are the Hedge Fund Masters of the Universe Buying?
Courtesy American Tower
52-week range: $86.21-$104.12
Market capitalization: $39.5 billion
Annual sales: $5.3 billion
Estimated 2015 earnings per share: $1.49
Estimated 2016 earnings per share: $2.42
Price-earnings ratio: 17*
Cell phone towers may be eyesores. But they rake in cash for American Tower (AMT, $93.25), the largest owner of such structures in the U.S. With a locked-in customer base of major telecom companies, American Tower doesn’t lose tenants often. Telecom firms sign multiyear leases to put antennas and other equipment on towers, which relay calls and wireless data. Once settled in, firms rarely remove their equipment because it’s usually too costly to switch to another tower.
American Tower borrows heavily to fund its business and could see profit margins slide if interest rates climb, driving up its debt expenses. Yet the firm, which is set up as a real estate investment trust, can raise rents modestly on its tenants. Business is thriving in countries such as Brazil and India, where mobile communications are taking off. Although the stock yields just 2.1%, American Tower aims to raise its dividend at a 20% annual clip in coming years. (As a REIT, the firm must pay out 90% of pretax income as dividends.) With rental income climbing steadily, the stock should deliver average annual returns in the “mid teen” percentages over the next five years, says David Rainey, comanager of the Hennessy Focus Fund.
* The P/E ratio for American Towers is based on price-to-funds from operations, a REIT industry standard that adds back depreciation and amortization to earnings.
SEE ALSO: 5 Great REITs with Attractive Yields
52-week range: $124.04-$151.63
Market capitalization: $313.2 billion
Annual sales: $226 billion
Estimated 2015 earnings per share: $6.90
Estimated 2016 earnings per share: $8.29
Price-earnings ratio: 15
Run by the maestro of moats himself, Berkshire (BRK.B, $127.04) combines a portfolio of underlying stock investments with an empire of companies that Buffett has assembled, including Benjamin Moore Paints, Geico and Fruit of the Loom. Although Buffett takes a hands-off approach to the businesses, they earn piles of cash that he can dole out as he sees fit. Even after paying $23 billion in cash (plus $10 billion in debt) for aerospace parts maker Precision Castparts—a deal expected to close in the first quarter of 2016—Berkshire should still have more than $35 billion on hand for investments and acquisitions, estimates James Wilhelm, manager of the Touchstone Focused Fund.
Buffett’s stock picks haven’t all panned out; partly as a result, Berkshire’s stock has lost 15.4% over the past year, trailing the S&P 500 by about 10 percentage points. Investors may also fret that Buffett, now 85, may not run the company for many more years. But the stock looks cheap, trading at about 1.2 times book value (assets minus liabilities), Buffett’s preferred method for valuing his company’s shares. That’s just below the five-year average of 1.3 times book value and right around the price at which Buffett says the stock would be cheap enough for Berkshire to buy back its own shares. Wilhelm says the stock could hit $170 over the next two years, based on the value of its underlying businesses and stock investments. Other Berkshire fans, such as hedge fund manager Whitney Tilson, think the shares can appreciate by 45% over the next year.
SEE ALSO: The Dumbest Investments Warren Buffett Ever Made
52-week range: $45.35-$68.19
Market capitalization: $103.7 billion
Annual sales: $32.8 billion
Earnings for fiscal year ended May 2015: $1.85/share
Estimated earnings for fiscal year ending May 2016: $2.15/share
Price-earnings ratio: 27
LeBron, Kobe, Odell. Athletes known by their first names dominate Nike’s (NKE, $60.88) roster of stars pitching its shoes, clothing and other athletic gear. And they’re helping the swoosh brand scale new heights. Sales are surging in China, where revenues climbed 24% over the past two years, reaching $1.8 billion in the six-month period that ended in November 2015. Over the next four years, Nike aims to hit $50 billion in global sales, up from an estimated $32.8 billion in its fiscal year that ends this May. Profits are climbing, too, with analysts expecting earnings per share to jump 16% in the current fiscal year.
The knock on Nike stock is that it trades at a lofty 27 times estimated earnings for the next 12 months. Moreover, Nike earns more than half of its profits abroad, where weakness in foreign currencies is denting its earnings when translated to dollars. But Nike’s profit margins have been climbing. And the firm recently authorized a 14% dividend increase and $12 billion share buyback over the next four years—both signs that Nike’s new products and expansion plans are on the right track.
52-week range: $33.13-$45.24
Market capitalization: $146.2 billion
Annual sales: $37.3 billion
Earnings for fiscal year ended May 2015: $2.77/share
Estimated earnings for fiscal year ending May 2016: $2.60/share
Price-earnings ratio: 13
Dominating the market for database software, Oracle (ORCL, $34.80) hauls in more than $37 billion a year from roughly 420,000 customers worldwide. Moats don’t get much bigger than that. But sales and profits have slumped because of the strong dollar. And Oracle’s fortress is buckling a bit. The firm must now compete against companies delivering software via subscription services through the “cloud,” cutting into Oracle’s model of selling big packages of hardware and software up front.
The bullish case for Oracle is that it isn’t sitting on its laurels. The firm is booking more cloud-based business, which now accounts for 7% of revenues but should become a much larger share in coming years. Sales of Oracle’s high-end hardware and business software products are gradually picking up. And the firm still makes plenty of money off its bread-and-butter database software and related products.
Oracle’s balance sheet swells with $54 billion in cash and short-term securities—money that it can use to reinvest in the business, increase its dividend or share buybacks, or snap up other companies. With the shares trading at 13 times estimated earnings, the stock looks like a bargain in comparison with other big software companies, says analyst Bill Kreher, of brokerage Edward Jones. “Oracle is making investments today that will eventually pay off,” he predicts.
SEE ALSO: 5 Best Tech Stocks for Dividends, No FANGs Required
52-week range: $101.88-$125.33
Market capitalization: $14.7 billion
Annual sales: $7.9 billion
Estimated earnings for fiscal year ending April 2016: $5.79/share
Estimated earnings for fiscal year ending April 2017: $6.43/share
Price-earnings ratio: 20
J.M. Smucker (SJM, $122.90) may be known for colorful jars of strawberry preserves. But the company has been swallowing other food brands, including Jif peanut butter, Folgers coffee and Meow Mix pet food. Acquisitions have lifted Smucker’s sales by an estimated 10% over the past three years, with revenues expected to hit $7.9 billion for the 12 months that end this April. Profit margins are also inching up as Smucker’s lowers manufacturing costs and uses its heft with retailers to expand sales of new products.
Smucker’s shares aren’t cheap, trading at 20 times estimated year-ahead earnings, 33% above the overall market’s P/E of 15. But Smucker’s earnings per share include some big noncash charges related to its acquisitions. Strip out those charges, says Timothy Fidler, comanager of Ariel Appreciation Fund, which invests in wide-moat stocks, and Smucker’s “cash earnings” should hit $7.35 a share in the 2017 fiscal year, about a buck per share higher than the average of analysts’ estimates. Based on measures such as price-to-sales, he adds, Smucker’s is one of the “few defensive stocks that’s both high-quality and attractively valued.”
52-week range: $37.73-$55.38
Market capitalization: $21.6 billion
Annual sales: $4.8 billion
Estimated 2015 earnings per share: $1.73
Estimated 2016 earnings per share: $1.88
Price-earnings ratio: 23
Many people want organic meat these days. But farmers still need to use antibiotics and other medicines in animal feed to keep their livestock healthy. Despite government pressure in Europe and the U.S. to reduce antibiotic use, things look bright for Zoetis (ZTS, $43.40), which makes a range of animal-health products and dominates the industry, with $4.7 billion in 2015 sales, well ahead of its closest rival in animal drugs, Merck.
Spun off from Pfizer (PFE) in 2013, Zoetis has developed multiple drugs that face scant competition. In 2009, the firm launched a novel vaccine for swine flu. In 2013, Zoetis came out with a drug to protect pigs from a type of pneumonia. Like medicines developed for humans, livestock drugs eventually lose patent protection. But farmers tend to stick with branded drugs, in part because their costs are relatively low in relation to animal feed and other production costs, and because farmers don’t want to risk a loss of animals with generic drugs that may not be as reliable.
Even with a slowdown in antibiotic use, analysts see Zoetis’s profits climbing by 5% in 2016. Although the stock isn’t cheap—trading at 23 times estimated 2016 earnings—the firm’s perch atop a steadily growing industry makes it a good long-term bet, says David Kalis, co-chief investment officer of Calamos Investments.
SEE ALSO: How to Invest for the Coming Bear Market
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