The wonderful thing about hearing the investing wisdom of Warren Buffett is that it isn’t overladen with long-winded explanations or high finance calculations. Considered probably the greatest investor of our time, the “Oracle of Omaha” isn’t out for high risk investments and doesn’t look at share prices when investigating the value of a business.
So what does he look for? In three words, it might be sustainable competitive advantage. Firstly, a company must have a competitive advantage that sets it apart from its competitors and protects it in some way from having to discount its product. A can of beans can only go down in price when compared to another can of beans.
Here are two quality companies that have strong competitive advantages and high margins.
Sirtex Medical Limited (ASX: SRX)
The maker of medical products for liver cancer treatments, it has a competitive advantage from its specialised technology that sets its products apart. One way investors can see a competitive advantage is by high profit margins and a high return on equity.
Sirtex usually achieves net profit margins of about 18% – 20%. A regular company could be operating with margins of anywhere between 2% and 10%, but when competition or a weak economy comes, that could be cut quickly.
Sirtex also has a high return on equity, usually around 20%. Average companies may get around 10% – 20%. It shows it is making good money on the investment of its net assets.
REA Group Limited (ASX: REA)
The operator of property sales website realestate.com.au is another company with both a high profit margin and return on equity. Over the past three years, its net profit margin is an average 30% and its return on equity is usually in the mid-30% range.
Buffett could see this company has a strong competitive advantage as the number one leading real estate website that keeps customers coming back again and again.
Are these two companies’ competitive advantages sustainable over the long-term? They could be. If their margins and returns can be maintained, then they can look forward to further strong growth. They both have high price/earnings ratios, but that’s the premium to be paid for their quality and earnings potential.