Warren Buffett said in his 1995 annual Berkshire Hathaway shareholder letter:
In business, I look for economic castles protected by unbreachable moats.
In other words, businesses protected by immense cash flows, unbreakable balance sheets, and robust competitive advantages look appealing to Buffett.
Both Autodesk (ADSK -2.76%) and Adyen (ADYE.Y 0.79%) fit this bill. While many growth stocks have struggled over the past year, the fortresses Adyen and Autodesk have built around themselves have helped them thrive during this challenging macroeconomic environment. Here's why Buffett should pay more attention to these two disruptive businesses, and why you should too.
1. Autodesk
Autodesk is the leader in the computer-aided design (CAD) market, with design software that controls 37% of the CAD space, and is the top dog in multiple different industries, including construction and engineering.
The company has created a thriving business that can survive in nearly any market environment. Even with a recession on the horizon impacting business budgets and war in Europe making businesses hesitant to spend more, Autodesk continued to post stable results. In its second fiscal quarter, which ended July 31, 2022, revenue jumped 17% year-over-year to $1.2 billion.
This has helped Autodesk build a robust economic castle. Its profitability is staggering, with a non-GAAP operating margin of 36% and a free cash flow margin of 20% in Q2. Autodesk also has a strong balance sheet, with over $1.5 billion in cash.
So it's clear that Autodesk has built a fortress, with profits and a balance sheet ready to survive anything, but its competitive advantage is even better. Switching costs for Autodesk customers are incredibly high. It's very difficult to switch to another system once a customer integrates Autodesk's services into its entire operations.
The company is also trying to expand into the project management field in addition to pre-construction planning. Autodesk Build -- its project management tool -- is gaining ground, with large enterprises already adopting this service in conjunction with its preconstruction tools. As customers adopt more products and become more engrained into the product ecosystem, those switching costs become even higher, creating a wide moat.
If there's one thing Buffett wouldn't like about Autodesk, it's that shares aren't cheap at 28 times free cash flow. While this is expensive in absolute terms, it is cheaper than some competitors like Procore Technologies.
Aside from its valuation, Autodesk looks like a perfect stock for Buffett. However, even if he doesn't buy shares, you might want to consider adding Autodesk to your portfolio.
2. Adyen
Adyen, the Netherlands-based digital payments processor, is another company that would seem to fit in Buffett's portfolio. Adyen takes a unique approach to attracting customers and having merchants expand their usage of its services. As enterprises use Adyen to process more of their digital payment volume, the company lowers its take rate on that additional usage.
This business model would be difficult for rivals like PayPal to replicate. PayPal only had a non-GAAP net income margin of 16% in Q2. Therefore, the company would likely see profits tumble if it dropped its take rate.
This unique model has allowed Adyen to have major success in the payment processing industry. Adyen saw a 37% year-over-year top-line increase to 608.5 million euros, while processed volume soared 60% over the same period to 346 billion euros in the first half of 2021.
The company is also immensely profitable, which is atypical for a company growing this fast. Adyen generated over 282 million euros in net income and 309 million euros in free cash flow in the first half of 2022, representing margins of 46% and 51%, respectively. This top-class profitability has led to its balance sheet being as sturdy as they come: Adyen has almost 5.6 billion euros in cash with no debt.
Just as Buffett likes, Adyen has a fortress balance sheet -- which will likely continue for a long time given its profitability -- and a durable advantage to help it keep growing. At just 20.5 times free cash flow, shares of Adyen don't look too expensive either. That's why Buffett might appreciate this stock, and why you should too.
