Warren Buffett coined the phrase “moat” to define the strength of a company's competitive advantage. Most companies have little to no moat, or protection from their competition. Others have very wide moats, meaning that they have structural advantages that keeps competition at bay.
When one thinks of a company with a wide moat, they usually think of very large businesses with scale, like Coca-Cola or Wal-Mart. Both have a wide moat, but they're also very big, slow growth stocks.
Here are three smaller companies with wide moats that deserve more attention from investors.
CH Robinson Worldwide
This third-party logistics (3PL) firm does not own its own trucks or trailers, but it is responsible for brokering a major share of all transportation throughout the United States.
The company's wide moat comes from its scale. It uses buying power, technical know-how, and relationships with various carriers to best the competition. Shipping is a very fragmented business where most operators are family-owned, often classified as small businesses with fewer than 50 employees. CH Robinson leverages the network effect to generate above-average returns on its invested capital.
CH Robinson is to shipping and logistics as Visa is to credit cards. CH Robinson does not own its own fleet, just as Visa does not loan money to its credit card users. Rather, these companies own a network that requires very little investment capital to generate profits. As such, CH Robinson excels with a ROIC higher than 30% in every year since 2005. For each $1 invested in the business, CH Robinson adds $0.30 more to bottom line profit.
Trading at 17 times next year's earnings estimates, CH Robinson is a relative bargain compared to the stock market as a whole. The company benefits from a secular explosion in the 3PL business, giving it a naturally growing customer base. Most importantly, the company's scale allows it to steal competition from smaller players in the industry.
Most people have heard of Western Union, but its $8.9 billion market cap doesn't necessarily make it a huge international company.
Western Union is in the business of immediate cash transfers--one stop at a Western Union agent location will allow you to send cash all over the world in a matter of hours. For that reason, it's a popular way for immigrants to send cash to their families back home. You can send funds to be picked up immediately in person, in cash, at any other Western Union agent location for a very small fee.
Western Union is also asset light. It recruits agents, who operate their own business using its brand name. A global network of more than 500,000 agents makes it the best player in the space. The network effect is particularly strong; why would entrepreneurs join any other network when Western Union has leading market share?
At nine times forward earnings estimates, Western Union is a bargain. Investors are essentially pricing the company for obsolescence given rising fund transfer options over the internet from companies like eBay's PayPal or Square. However, Western Union is in a differentiated business as it offers instant transfers in cash. Online competitors deal in electronic fund transfers that can take a week or more for the receiving party to turn into cash.
A pharmacy benefit manager, this company works as a third-party administer of employee drug plans. The company seeks to lower the total cost of prescription drugs for its customers, who face the risk of rising health care prices. In return, Express Scripts generates impressive margins.
The company's moat comes from its scale. As its sole job is to lower the cost of drugs for its customers, it uses its buying power to negotiate lower prices for prescription drugs. In short, Express Scripts is to prescription drugs what Wal-Mart is to retail.
Some 100 million members receive their prescriptions from an Express Script's managed plan, making it the largest player in the space (CVS Cammark) is second in the business by a wide margin. Other smaller players are being pushed out of the business, unable to compete with low pricing from the market leaders.
The company trades at less than 12 times forward earnings expectations and has a history of impressive returns on invested capital. ROIC was in the double-digits for every year in the last decade, with the exception of 2012, when the company acquired Medco. Going forward, the company should continue to deliver excellent returns on each incremental dollar deployed in the business.