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According to Warren Buffett, one of the most important things when it comes to finding stocks to buy is something that has protection from disruption. And the FTSE 100 has some great examples.
One that doesn’t always get the attention it deserves is Compass Group (LSE:CPG). The contract catering firm isn’t exactly a household name, but its competitive position is incredibly strong.
Economic moats
If a business starts doing well, it’s only a matter of time until competitors start to think about copying it. So to be successful over the long term, a company needs something that rivals can’t easily emulate.
Barriers to entry in the contract catering industry are relatively low – there are no patents or anything like that. But Compass gets a big advantage from the scale of its operations.
The ability to order in greater volume means the opportunity to negotiate lower costs from suppliers. As a result, the FTSE 100 company is often in a position to charge lower prices than its rivals.
This is a key advantage for any business. And while it might not be difficult for new organisations to enter the contract catering market, achieving the firm’s scale advantage is a different matter.
Customer retention
Possibly the biggest test of a company’s economic moat is how well it retains its customers. And on that score, Compass is very impressive – it has a retention rate of around 96%.
That’s industry-leading. And part of the customer turnover has nothing to do with the firm losing market share – it’s the result of venues – such as offices – shutting down.
That means the biggest threat might not be other competitors. It might be more to do with the danger of venues closing – and this is a live issue in the US right now, especially in the hospital sector.
It’s worth noting, though, that Compass has more than managed to offset this by winning business elsewhere. And as it does this, its scale advantage increases further.
Purchasing power
Compass uses its scale advantage in two ways. One is by negotiating lower prices from suppliers, but there’s also another, less obvious, benefit.
The FTSE 100 company also lets third parties purchase through its procurement platform – in exchange for a fee. Importantly, everyone involved benefits from this.
Organisations using the Compass purchasing network benefit from lower prices that they can pass on to customers. And Compass collects high-margin revenue it otherwise wouldn’t have earned.
This also increases the firm’s scale, which further strengthens its competitive position. As a result, I think Compass has one of the widest moats in the FTSE 100.
A stock to watch
It seems unlikely that venues are going to want to bring their catering operations in-house any time soon. Given this, a company with a strong competitive position in this industry could well turn out to be a good long-term investment.
That’s why I have Compass on my watch list at the moment. I’m not entirely averse to buying it at today’s prices, but the recent market volatility has got me looking at other opportunities right now.
The key to the firm’s resilience is its scale, which is nearly impossible for a competitor to emulate. As a result, it has one of the widest moats in the FTSE 100.
