Moat Report Card: Polo Ralph Lauren

In our Moat Report Card series, we test a company's ability to fend off competitors by analyzing the returns it generates on the funds it invests – its ROIC.

We ask three questions:

1. Over time, has the company earned a sufficiently high ROIC?
2. Is the ROIC of high quality?
3. Is the company maintaining and growing the returns it earns on invested capital?

(Need more detail? Check out our full explanation of the scorecard.)

Let's see what Polo Ralph Lauren's (NYSE: RL) returns on capital can tell us about the breadth, depth, and alligator-filled-ness of the trendy clothier's moat.

ROIC history
We'll start by examining how Polo's three-year rolling ROIC has changed over time, and in relation to its nearest competitor, Phillips Van Heusen (NYSE: PVH):

Data from Capital IQ, a division of Standard & Poor's.

Polo and other Ralph Lauren brands have exhibited remarkable staying power for decades. You know the brand and its logo -- a polo player atop a galloping horse -- and you've probably purchased its products. Even though switching costs are low and substitutes are plentiful, the power of the horse can be seen in the company's consistently high rolling returns on invested capital.

Like the Polo brand, Ralph Lauren's rolling returns only seem to be getting better with time. Well in excess of our 10% hurdle, Polo Ralph Lauren's returns edge out Phillips Van-Heusen (seller of Calvin Klein, IZOD, and DKNY goods) and easily outpace the rest of the industry. Polo scores a goal with nine out of 10 possible points in the ROIC Hurdle category, losing a point only because of the admirable performance of its nearest rival.

ROIC quality
Just like return on equity, there are only so many ways a firm can juice its ROIC. The three main levers are profit margins, asset turnover, and leverage. Here's how they measure up at Polo Ralph Lauren:

Data from Capital IQ, a division of Standard & Poor's.

Product line extensions, pricing power, and cost reductions have allowed Polo to increase its after-tax operating profit margins over time. Coupled with increased efficiency, the firm's operating return on assets has risen to 12.3%, up from a 10% average the first few years of the decade. The company takes its polo mallet to the competition in terms of ROIC, even when assuming industry average leverage. Polo Ralph Lauren gallops to a perfect five points because of the high-quality makeup of its returns.

ROIC growth

Data from Capital IQ, a division of Standard & Poor's.

Polo continues its winning streak by growing its rolling ROIC at an average rate of 2.1% over the past five years. However, it appears that Phillips Van-Heusen has been taking notes, and has improved its own business and returns to a larger degree. Even so, it's hard to fault Polo for simply retaining a high level of business performance.

The company's ROIC growth looks even more impressive when compared to competitors Liz Claiborne (NYSE: LIZ) and Jones Apparel (NYSE: JNY). These two rivals prove that popular brands alone aren't enough to compete in this industry. Liz Claiborne controls Juicy Couture, Lucky Brand, and Kate Spade, while Jones Apparel hawks Nine West and Anne Klein. But both retailers have struggled to appeal to cash-strapped consumer and compete against both private and more powerful brands. The companies have seen their returns on capital generally decline over the past few years.

Pencils down!
With all the numbers in, here's how Polo Ralph Lauren scored:

Polo Ralph Lauren earns an A on its Moat Report Card. This is an impressive feat, given how notoriously fickle and competitive the fashion industry is. Maintaining the integrity of the company's brands, yet embracing popular discount retailers like TJX's (NYSE: TJX) T.J. Maxx, is always a delicate balancing act.

Remember to look forward and assess whether the company's moat is enduring, and buy at a reasonable valuation. Your portfolio will stand a better chance of surviving the occasional market siege.