Hey Guys and Gals,
As a trader, you should always be searching for ideas where the security you’re looking to trade is either outperforming or has the potential to outperform the broader market.
When the broader market is showing weakness as it was earlier this week, that means bullish traders must look for stocks that have been showing strength in the face of adversity.
One method that can assist a trader in this process is to look for companies that have an “economic moat.”
Today, we’ll discuss the meaning of this term, uncover how a company achieves this status, and identify one company with an economic moat that has been developing a strong long-term price trend of late.
Obviously, when we think of a moat we think of a large trench that would have been dug around a medieval castle and filled with water to protect against attack.
The wider and deeper the moat, the more protected the castle.
Ever since Warren Buffet described ‘economic moat’ as his main investment strategy during an interview with Fortune magazine in 1999, there has been a lot of interest in this term.
During this interview, Buffet proclaimed, “The key of investing is not addressing how much an industry is going to affect the society or how much it will grow. But, rather determining the competitive advantage of a company. The products or services that have wide and sustainable moats around them are the ones that deliver rewards to the investors.”
Quite simply, if a company has an economic moat it holds a competitive edge over others.
Companies with economic moats have rapid growth potential and high profit potential.
Typically, having an economic moat allows the company to keep growing and gaining market share, ultimately leading to increased profitability.
How does a company achieve a strong economic moat?
It takes years for a company to build an economic moat.
It’s a process that depends largely on building a strong enough brand that demands pricing power.
In other words, no matter if the company decides to increase the price of its goods or services, the company’s products are so highly desired that there will be no drop in demand.
This is because the company has invested in the following, thereby building the customers preference for their product and brand.
- Product development
- Distribution and sales
Finally, patents and licenses protect the production process of the company’s products.
How can you identify a company with an economic moat?
Now that we have an understanding of the meaning of economic moat, here’s how to identify companies with economic moat.
First, the stock shows solid performance in a slow economy.
Second, companies with strong economic moats will always control market share over their competitors.
I like ServiceNow, Inc. (NOW) for its strong moat and technicals
ServiceNow, Inc. (NOW) provides cloud-based services that automate enterprise IT operations. The Company’s service includes a suite of applications built on its platform that automates workflow and integrates related business processes. It focuses on transforming enterprise IT by automating and standardizing business processes and consolidating IT across the global enterprise. ServiceNow, Inc. is based in San Diego, CA.
ServiceNow not only earns a wide economic moat rating but boasts a positive moat trend, too.
The company has done an exceptional job of expanding beyond its software-as-a-service solution for IT service management into the larger IT operations management market.
Technically, as Figure 1 shows, the stock has been rising in a well-defined upward price channel since the 2nd half of 2020, and is up 22% month-to-date.
As we zoom in, Figure 2 shows that, from current levels, there is still an upside potential of 8% until the top of this channel becomes resistance again.
Essentially, there are two ways for a trader to approach entry into this stock.
First, for traders that want to be more aggressive, believing that NOW will continue to rally from here without interruption, a stop can be placed at the most recent pivot low of $640.12 (see red line in Figure 2).
Why the $640.12 pivot?
Because, by definition an uptrend is a series of higher lows.
Therefore, if NOW were to fall back below this level, the most aggressive path higher (i.e., the most recent uptrend) would suffer an important technical breakdown.
IF such a breakdown were to occur, it would increase the odds of a better buying opportunity developing as the stock tests the $600 breakout area (see black line in Figure 2) and rising 50-day moving average (see blue line in Figure 2), which, as Figure 2 also shows, has a proven track record of acting as strong support.