BAE (LSE: BA) (NASDAQOTH: BAESY.US) ticks one of the most important parts of my investment checklist: it enjoys vast barriers to entry.
I look for this as a key aspect of any company because, put simply, it means that over the long run a company is likely to be much more profitable. The reason for this is, again, quite obvious in so far as a lack of new entrants means less disruption and the chance for incumbent firms to maintain (and even expand) margins.
So, the fact that the industry in which BAE operates has high entry barriers is a major plus for me, with military contracts only being awarded to companies that fulfil certain criteria and which governments can accept as their suppliers.
Not all companies pass these rigorous requirements and even fewer possess the capital required to acquire the plant and equipment with which to manufacture military assets. Further entry barriers exist in terms of the knowledge and expertise required to develop military goods, with there being a limited supply of this resource available.
So, onerous government requirements and large amounts of human and physical capital mean that barriers to entry are high in the industries in which BAE operates. However, that’s not the only reason I’m bullish on the shares.
Indeed, BAE is highly profitable, as evidenced by an impressive return on assets ratio. Last year BAE delivered return on assets of 4.8%, which is a very impressive figure when the large amount of intangible assets on the balance sheet are taken into account.
Furthermore, return on assets have been consistent over the last three years, ranging from 4.5% to 5.4%. This highlights the predictability and stability of BAE’s returns, which gives me further confidence in the company.
In addition, BAE appears to offer good value at current price levels. Its free cash flow yield is very impressive at 12.5% last year; even though capital expenditure is relatively high. Indeed, higher levels of capital expenditure are well within its capability, should the business wish to increase its total asset base.
So, I’m bullish on BAE because of its extremely high barriers to entry, impressive return on assets and the good value that shares appear to offer as shown by the free cash flow yield.
