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In this article, you will learn how to analyze a competitive advantage (moat) by using the Morningstar framework.
The Data on Competitive Advantages
Before we get into the framework, let’s take a look at the data supporting competitive advantages being important:
Morningstar’s Wide Moat Focus Index has performed well versus the S&P 500 since its inception in 2007:
Morningstar’s research suggests that the median annualized 10-year total return is:
+10.6% for wide moat businesses
+8.6% for narrow moat businesses
+3.3% for no moat businesses
A key characteristic of a quality business is that there is an economic moat that protects the above-average return from competitors.
Data from Schroders suggest that Quality and Quality at a reasonable price outperform the Index (MSCI UK) over 30 years.
Assumption: Most of the quality companies in the study have a wide or narrow moat
The Morningstar framework
The framework is built on 5 “moat sources”:
Intangible assets (Coca-Cola)
Switching Costs (Oracle)
Network Effects (CME Group)
Cost Advantages (UPS)
Efficient Scale (Kinder Morgan)
Intangible Assets
One of the strongest moat sources in the framework.
Intangible assets include brand value, patents, and licenses. These are by definition hard/impossible to replicate.
Imagine trying to compete with Coca-Cola. Coca-Cola has built its brand over millennia. This value is hard to value, but it the brand value makes consumers pick their products over other soft drinks.
Examples: Johnson & Johnson, Unilever, Sanofi, Coca-Cola.
Switching Costs
Another strong moat source happens when the expected value of switching to another vendor is lower than the perceived costs of making the change.
Companies that deliver software to a business often have switching costs moat. The software might not be fantastic, but it gets the job done, and the business is busy with more important projects than changing the ERP system for example.
Example: Intuitive Surgical, ADP, Oracle.
Network Effects
The strongest moat source occurs when the value of the product or service increases as more customers join.
For example, the more customers that shop on Amazon, the more companies want to sell their products on Amazon. And the more products Amazon has, the more customers want to join as the number of products increases.
Examples: Mastercard, eBay, Meta Platforms, CME Group.
Cost Advantage
Cost advantage is the second lowest-performing moat source and occurs when businesses have a structural advantage that allows them to produce their products at a lower cost than their competitors.
The moat source is not the strongest, but the sustainability of the moat can be held for longer than other sources.
Examples: Amazon, Abinbev, Novo Nordisk, Shell.
Efficient Scale
Generally, the lowest-performing moat source occurs when a market is limited in size, and the participants efficiently meet the market demand.
Incumbents generate economic profits.
Examples: UPS, National Grid, Carnival
Counterpoint Global’s wide moat list
A list of companies with competitive advantages:
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Our 5 favorites from the list:
Amazon AMZN 0.00%↑
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Evolution AB $EVVTY
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Read our other article on wide moat businesses:
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Good 101 breakdown. But moats aren’t static — regulators, tech shifts, or new competitors can tear them down quick. That’s the part investors miss.
The Buffett-Munger Profitability_And_Assets_Productivity_Investing Truism Dharma 168:
CompROA Ratio and FPR
i.
CompROA Ratio (Competitive Return On Asset Ratio, by ATC)
= ∛(Revenue × Gross Profit × Net Profit) ÷ Total Assets
FPR (Finance Pressure Ratio, by ATC)
= Total Assets ÷ ∛(Revenue × Gross Profit × Net Profit)
= Inverse of CompROA
= 1 ÷ CompROA
ii.
If CompROA Ratio ≤ 0.2109 or FPR ≥ 4.743
= It implies Weak Competitive Advantage with Weak Profitability & High Finance Pressure
= Not a Compounder
iii.
If CompROA Ratio ≥ 0.4217 or FPR ≤ 2.371
= It implies Strong Competitive Advantage with Strong Profitability & Low Finance Pressure
= Poised to be a Multi-bagger Compounder, the magnitude depends on the synergy between the ROIC & Gnp
= Having a long compounding runway time horizon
Reference:
Profitability_And_Assets_Productivity_Investing Truism Dharma 162