If you've been reading my investment commentary for long, then you know that I place a great deal of importance on economic moats. In the simplest terms, these are sustainable advantages that protect a business from marauding competitors seeking to pillage its profits.
Without some type of moat, it's nearly impossible for a company to sustain superior returns on invested capital. All of the world's most profitable businesses have some type of moat... Apple (Nasdaq: AAPL), Amazon.com (Nasdaq: AMZN), Wal-Mart (NYSE: WMT)...
Why I trade the same stock over and over again
Needless to say, it's an enviable position. Most industries have nothing to prevent new rivals from crowding in and elbowing for space. Just take fast-food chains for example. They wage a never-ending battle for market share and must usually sacrifice profit margins to attract and retain customers.
The same is true of grocers, department stores, and countless other cutthroat industries.
But with daunting barriers to entry, it's difficult (if not impossible) for newcomers to break in. So the market isn't carved up into thin slices. The entire heaping pie is served up to one or two lucky incumbents.
4 Barriers To Entry
There are several different barriers that help dissuade would-be competitors from setting up shop. Here are four of the most common deterrents.
1. Regulatory Hurdles. Some industries are governed by layers of rules, regulations and oversight that scare away potential players. Slot machine makers, for example, must get the blessing of gaming control boards and other regulatory bodies before they can even think of putting a product on the market.In some cases, the powers-that-be go out of their way to limit the playing field. The credit ratings business is a textbook example. Stringent SEC qualifications make it nearly impossible to get a toe-hold in this industry, so a small handful of lucky firms like Moody's (NYSE: MCO) rake in all the profit.
Even garbage dumps can be a goldmine for investors. Waste must be hauled away somewhere, but nobody wants a new landfill in their backyard. Securing necessary permits, environmental zoning variances, and operating licenses can be a nightmare. That makes existing sites quite valuable.
Waste Management (NYSE: WM) owns 250 permitted landfills across the country. And with stout regulatory roadblocks to new ones, the company has few large-scale competitors. It even collects "tipping fees" from smaller regional players that use one of its sites.
2. Capital Requirements. Anybody with a few thousand dollars and decent skills in the kitchen can open up a new diner. That's why they are found on every street corner. But some industries require hundreds of millions, or even billions, just to get in the game.
Building a state-of-the-art semiconductor manufacturing facility doesn't come cheap. Same story for nuclear submarines. There are only six shipyards capable of building these vessels on the Navy's speed-dial, and General Dynamics (NYSE: GD) owns three of them.
Royal Caribbean's (NYSE: RCL) newest cruise ship cost a staggering $1.3 billion to build. Ordering just one of these amenity-laden vessels can be prohibitively expensive -- let alone an entire fleet.
3. Patents and Licenses. Researching, developing, and ultimately commercializing a new product can be expensive and time-consuming. But if that product is awarded a patent, then the government itself is putting up a "keep out" sign to would-be rivals.
One of the most obvious examples involves pharmaceutical or biotech drugs. Abbvie's (Nasdaq: ABBV) Humira, which is used to treat arthritis and other auto-immune disorders, rakes in nearly $20 billion in annual sales. It will be another four years before protective U.S. patents expire and generic competition is introduced.
Then there are tech companies like Qualcomm (Nasdaq: QCOM), whose breakthroughs in the early 2000s are still generating royalty income from the sale of most mobile phones worldwide.
4. Contracts, Concessions, and other Agreements. Municipal, state, and federal governments often privatize certain functions or otherwise grant a limited number of permits to conduct operations. Those lucky enough to win one of these coveted concessions can milk them for years to come, often free of competition.
Case in point, there are hundreds of general aviation (i.e. private and charter plane) airports across the country such as Fort Lauderdale Executive and North Las Vegas. Refueling and concierge services are often handed to a single vendor, called a fixed-base operator (FBO). That's a bit like operating the only gas station in town.
Macquarie Infrastructure (NYSE: MIC), has a subsidiary called Atlantic Aviation that has been granted exclusive privileges at 60 airports from Portland, Oregon, to San Antonio, Texas. That steady income supports a lofty 10%-plus dividend yield.
Action To Take
Quite a few of my investment recommendations over the years benefit from barriers to entry. That includes drug companies, power and gas utilities, and railroad owners (whose routes are protected by right-of-way permits), among others.
My most recent Daily Paycheck portfolio pick is in the same vein. It has been awarded exclusive contracts to handle interstate logo display signs for 23 different states.
And that's only one part of the business. It also leases advertising space on roadside billboards throughout North America. There are strict limits on new installations, which shuts out potential competition and maintains an oligopoly for the existing market leaders.
With these contracts in hand, all that's left is to sit back and collect a steady stream of advertising income. Most of which is handed right back to stockholders, of course.
I won't share the name of this pick today, since it wouldn't be fair to my subscribers. But I've already thrown out a few picks that are worth looking into further.
Just know that my subscribers over at The Daily Paycheck have been using stocks like this to build a powerful portfolio that throws off thousands of dollars in extra income. In fact, we're on pace to earn $1,563.15 in October. And it's not too late for you to get started.