The Motley Fool: Every Sunday, useful tips on investment
Q: What does it mean when a company is said to have a moat? Surely it isn’t headquartered in a castle, right?
A: Well, think of a company as being an imaginary castle. If it has a wide moat, it will be well defended, making it hard for any enemies to attack it.
In business jargon, an economic moat refers to sustainable competitive advantages that a company may have that protect its market position and defend against competitors or would-be competitors.
Examples include brand power, switching costs, patents, economies of scale and barriers to entry.
It’s hard for upstarts to compete against a powerful brand, and hard for any company to enter certain industries where startup costs are steep (think airplane manufacturing, for example).
Switching costs can keep many customers from changing to a different cellphone carrier or platform.
Seasoned and beginning investors alike can be confused by financial jargon. Hone your financial literacy with this mini-glossary:
Basis point: Most often used relating to changes in interest rates. One basis point is 1/100th of a percentage point.
Institutional investors: These include pension funds, insurance funds, mutual funds and hedge funds.
Margin account: A brokerage account that permits the owner to borrow money to buy securities. Margin accounts shouldn’t be used by inexperienced investors, or those who are putting money at risk that they can’t afford to lose.
Prime rate: The interest rate that lenders charge their best, most reliable customers.
Real return: The inflation-adjusted returns of an investment. For example, the stock market averaged an annual return of about 10 percent during the 20th century. If you subtract the annual inflation rate over the same time period, roughly 3 percent, you arrive at the real return — approximately 7 percent annually.
Underwriter: A brokerage firm that helps a company go public in an initial public offering (IPO). The firm underwrites (vouches for) the stock. When a company has been brought public, the shares have been underwritten.
Dear Fool: I bought shares of Netflix at $10 per share. I watched it get to the high $50s and then swoon, falling to the mid-$40s.
I decided to get some income from the stock, so I sold a call option on it with a $60 strike price, so that whoever bought the option could buy my shares for $60 during a certain period.
Well, that was dumb. Netflix moved past $60 so quickly that it made me dizzy. I got my $60 per share, but I missed so much more.
Lesson: Ride your big winner the few times you have one and use trailing stops to lock in profits.
The Fool responds: You’re right; with Netflix shares recently surpassing $470 per share, you missed a bundle. It might help to think about each of your holdings and jot down why you’re holding it — say, for income or for growth.
And be careful with trailing stop-loss orders, which instruct your broker to sell if the stock falls by a certain amount. They could eject you from the stock prematurely, due to temporary volatility.
It may seem like you’ve arrived too late to profit from stocks trading near their 52-week highs, but that’s not always the case.
Consider Capital One Financial Corporation (NYSE: COF), the successful consumer and commercial banking franchise with a strong market position in credit cards, auto loans and home loans.
Capital One has a convincing track record in growing its core business segments and has become the 13th-largest domestic bank in terms of total assets.
Thanks to cyclical tail winds generated by higher consumer spending, Capital One’s business segments should experience significantly higher demand, which should translate into higher share prices.
Indeed, in May the bank recently reported its first uptick in domestic credit-card loan growth in almost a year. (A recent study by CardHub ranked Capital One first in offering cards with the fewest limitations on their rewards.)
Capital One is resilient. During the financial crisis, its losses were small and it exceeded 2006 profitability levels as early as 2010.
Thanks to its strong balance sheet, the bank plans to funnel back substantial amounts of cash to shareholders in the form of dividends and share buybacks.
Capital One is worth considering for your portfolio. Its recent P/E ratio of 11.6 is below its five-year average of 14.1, and it offers a 1.4 percent dividend yield.