Competition has heated more than ever in almost every sector in recent years. Consequently, it has become challenging for investors to identify companies that enjoy a wide business moat. Wide moat stocks are great candidates for the portfolios of income investors, as they are usually characterized by reliable business performance, resilience to recessions and long dividend growth streaks.

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In this article, we will discuss the prospects of three stocks with wide business moats, namely Microsoft (MSFT), 3M (MMM) and State Street (STT).

Microsoft

Founded in 1975, Microsoft develops, manufactures and sells software and hardware to businesses and consumers. Its offerings include operating systems, business software, software development tools, video games and gaming hardware as well as cloud services. Microsoft has a market capitalization of $1.84 trillion, the second-largest in the stock market after Apple (AAPL).

Microsoft has a wide moat in the operating system & Office business units and a strong market position in cloud computing. The tech giant is unlikely to lose market share in its older, established products, while cloud computing is such a high-growth industry that there is enough room for growth for many players. Microsoft has an unparalleled reputation worldwide and thus its brand is one of the strongest in the global business landscape. Given also its immense global network, the company enjoys significant competitive advantages.

Moreover, Microsoft has repeatedly proved resilient to recessions. In the coronavirus crisis, while many companies came under great pressure, Microsoft grew its earnings per share by 21% in 2020 and by another 38% in 2021, to new all-time highs. The company also has one of the strongest balance sheets in the investing universe, with an AAA credit rating.

Microsoft stumbled during 2011-2015 but it managed to return to its multi-decade growth trajectory thanks to a change in management and a strategic shift towards cloud computing and mobile. The cloud business is growing at a fast pace thanks to Azure, which has been growing tremendously. The Office product range, which had been a low-growth cash cow for years, has accelerated in recent years, as Microsoft changed its business model towards the Office 365 software-as-a-service (SaaS) system. Overall, Microsoft has grown its earnings per share at a 14.8% average annual rate over the last decade.

Microsoft has raised its dividend for 21 consecutive years. The stock has a payout ratio of only 27%, a rock-solid balance sheet and ample room for future growth. As a result, it can continue raising its dividend meaningfully for many more years. The tech giant has grown its dividend by 10% per year on average over the last five years. However, as the stock has nearly tripled over the last five years, it is currently offering a nearly 10-year low dividend yield of 1.1%. Nevertheless, Microsoft is attractive right now thanks to its reasonable valuation level, which is in line with its historical average, its unique competitive advantages and its promising growth prospects.

3M

3M sells more than 60,000 products that are used every day in homes, hospitals, office buildings and schools around the world. It has approximately 95,000 employees and serves customers in more than 200 countries.

3M enjoys a wide business moat thanks to its proven ability to innovate. The company has a clear goal of spending 6% of sales (~$2 billion annually) on R&D in order to create new products and satisfy consumer demand. This strategy has proven a great growth contributor, as 30% of the sales during the last fiscal year came from products that did not exist five years ago. The exceptional R&D department of 3M has resulted in a portfolio of more than 100,000 patents.

3M has also proved fairly resilient to recessions. Thanks to its meaningful business moat and its resistance to recessions, 3M has one of the longest dividend growth records in the investing universe, with 64 consecutive years of dividend growth. Moreover, the stock is currently offering a nearly 10-year high dividend yield of 4.8%. Given the decent payout ratio of 58% and the competitive advantages of 3M, its dividend should be considered safe for the foreseeable future.

The only caveat is the risk of several lawsuits facing the company right now. There are nearly 300,000 claims that its earplugs, which were used by U.S. combat troops and were produced by a subsidiary, were defective. The subsidiary filed for bankruptcy but a U.S. judge ruled that this bankruptcy would not stop lawsuits against the parent company. Therefore, the final liabilities of 3M remain unknown. This is a significant risk factor to consider. Nevertheless, while no-one can predict the final amount that 3M will pay for the defective earplugs, the company is likely to recover after this case settles, partly thanks to its rock-solid balance sheet.

State Street

State Street is a financial services company that traces its roots back to 1792. It is one of the largest asset management firms in the world, with $3.3 trillion of assets under management and $36 trillion of assets under custody and administration.

State Street is one of the market leaders in the business of asset management and asset servicing. It also benefits from its economies of scale, which pose a barrier to potential new entrants. However, the company also competes against names like Vanguard, BlackRock and Bank of New York Mellon, which are in the process of reducing fees in an effort to attract new customers. The heating competition somewhat limits the growth potential of State Street.

On the bright side, State Street has exhibited an exceptional performance record, as it has grown its earnings per share in 8 of the last 9 years. Since 2012, the company has grown its earnings per share at a 6.7% average annual rate. It is also important to note that State Street has proved resilient throughout the coronavirus crisis, with record earnings per share in 2020 and 2021.

Moreover, due to the impact of inflation on the valuation of the stock market, State Street is currently trading at a nearly 10-year low price-to-earnings ratio of 9.9, which is much lower than its 10-year average price-to-earnings ratio of 13.1. The stock is also offering a nearly 10-year high dividend yield of 3.4%, with a solid payout ratio of 34%. As soon as inflation begins to subside, the valuation of this high-quality stock is likely to revert towards normal levels. Therefore, investors should take advantage of the exceptionally cheap valuation of the stock and wait patiently for inflation to subside.

Final Thoughts

The above three companies enjoy a meaningful moat in their business, in sharp contrast to the vast majority of companies, which operate in a highly competitive business environment. The merits of their business moat is clearly reflected in their exceptional growth record. As these three stocks have incurred a considerable decline in the ongoing bear market, they have become attractive from a long-term perspective. As soon as inflation begins to moderate, these stocks are likely to highly reward investors.

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