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1、 2008 Morningstar, Inc. All rights reserved.Durable Competitive Advantages: Using Economic Moats to Improve Investment ReturnsPat Dorsey, CFA Director of Equity Research2AgendaOur Approach to Competitive AnalysisWhat is an Economic MoatWhats NotWhere Morningstar Finds MoatsWhy Moats MatterUsing Econ

2、omic Moats in the Investment Process3Whats A Moat?Capital seeks the areas of highest potential return, so all firms face competition that seeks to force down high returns on capital. But some firms generate high returns for a very long time. How? By creating economic moats around their businesses.An

3、 economic moat is a structural business characteristic that allows a firm to generate excess economic returns for an extended period. Note that “structural” means “inherent to the business.”Smart managers and great execution are important, but theyre not structural attributes.4Whats a Moat?The key t

4、o having an economic moat is the sustainability of excess returns, rather than the absolute level of return on capital. A company with 40% returns on invested capital (ROIC) due to a hot product has no moat. The returns cannot be forecasted with any level of confidence. Fashion stocks (Crocs, Heelys

5、), Motorola RazrA company with 12% ROIC and a low cost of capital that is structurally protected from the competition may have a wide economic moat, because we can forecast those returns with a high degree of confidence. Pipelines, Railroads5Sources of Economic MoatsIntangible AssetsBrandsPatentsApp

6、rovals & LicensesCustomer Switching Costs The Network EffectCost AdvantagesProcessLocationUnique AssetsScale6Sources of Economic MoatsIntangible assetsBrands: Does it increase the consumers willingness to pay, or reduce search costs?Sony vs. TiffanyDoublemint & Juicy FruitPatents: Valuable,

7、but subject to expiration & challenge.Big pharma vs specialty pharmaLicenses & Government Approvals.Waste haulers, aggregate companies7Sources of Economic MoatsSwitching Costs: Do the costs in time or money of switching to a competing product/service outweigh the benefits?Monetary/Labor Cost

8、s-Oracle-Autodesk-Data processorsLow or uncertain benefits from switching-Amazon-Asset managers 8Sources of Economic MoatsThe Network Effect One of the most powerful types of competitive advantage, which occurs when the value of a good or service increases with the number of users. Examples of the N

9、etwork EffecteBay Western UnionMasterCard, American Express, Discover, VisaMicrosoftFinancial Exchanges9Sources of Economic MoatsCost Advantages Not necessarily tied to sizeProcess Invent a cheaper way of delivering a good or service that rivals cannot (or will not) replicate. Dell, Nucor, Steel Dyn

10、amics, Southwest/other LCCs.Low-cost resource base Ultra Petroleum, Compass Minerals.Scale-Distribution Stericycle, Cintas, Sysco, UPS-Manufacturing Intel-Niche Markets/Single-Scale Efficiency Graco, Blackbaud10Whats Not An Economic MoatSize / Dominant Market Share: High market share does not give a

11、 firm a moat. (Ask Compaq or GM.) In fact, market share may be irrelevant bigger is not necessarily better. Technology: What one smart engineer can invent, another can improve upon. (Exception: Creating a standard thats widely adopted.)Easily-replicable cost advantages (lean manufacturing, outsourci

12、ng.)Hot Products: Krispy Kreme, Tommy Hilfiger, Crocs, Iomega, etc.Can generate high returns on capital for a short period of time, but sustainable returns are what make a moat.11Whats Not An Economic MoatManagement: Smart managers may create a moat over time, but great management is not a moat by i

13、tself. Go for a business that any idiot can run because sooner or later, any idiot probably is going to run it. Peter Lynch“When management with a reputation for brilliance tackles a business with a reputation for poor economics, it is the reputation of the business that remains intact.” BuffettMana

14、gement matters, but moats matter more.12Where Morningstar Finds Economic MoatsThree groups: Wide, Narrow, and None.Wide moats are tough to find. Less than 10% of the 2100 companies that we follow have wide economic moats. (169, to be precise.)Moats vary by sector & industry. Fewer moats in highl

15、y commoditized or competitive sectors like computer hardware, consumer services (retail/restaurants), or industrial materials. Only 1/3 of the companies in these three sectors are wide/narrow moat.More moats in areas with high switching costs (data processors) and durable brands (consumer products),

16、 13Why Moats MatterMoats add intrinsic value!A company that is likely to compound cash flow internally for many years is worth more today than a company which isnt.Wide Economic MoatNo Economic MoatNarrow Economic MoatROICROIC ROICTime HorizonTime HorizonTime Horizon14Why Moats MatterWhen comparing

17、two companies with similar growth rates, returns on capital, and reinvestment needs, the company with the moat has a higher intrinsic value.Underestimating a moat results in opportunity cost, while overestimating a moat can cause you to pay for value creation which never materializes. Some fast-grow

18、ing companies are worth the premium, because the excess returns are more likely to persist. If a firm has a wide moat that will allow it to reinvest cash flow at a high rate of return for many years, what looks expensive may actually be quite a bargain.15Why Moats Matter“Time is the friend of the wo

19、nderful business, affording it the opportunity to reinvest incremental capital at favorable rates and increase the value of the enterprise. Over time, the price you paid for a terrific company looks cheaper and cheaper. For the inferior business at the cheap price, time may turn out to be the fell d

20、estroyer.“ Bob Goldfarb, Sequoia Fund16Why Moats MatterMoats enforce investment discipline.High returns on capital will always be competed away eventually.For most companies (and their investors), the regression to the mean is fast and painful.But a few generate excess returns for many years, and mo

21、ats give us an analytical framework for selecting them. 17Why Moats MatterCompanies with moats have greater resilience. If a firm can fall back on a structural competitive advantage, its more likely to recover from temporary troubles. This is a great psychological backstop for the investor whos buyi

22、ng when everyone else is screaming “sell!” If youre confident in the moat, its easier to average down if you initiate a position too early. 18Isnt the Moat Already Priced In?Short answer: Sometimes, but less frequently than you might think.Long answer:Most market participants own securities for shor

23、t time periods, and moats matter much more in the long run than over the short term. (Time-horizon arbitrage.)Recency bias causes most investors to assume that the current state of the world (good or bad) persists for longer than it usually does. Our performance record suggests that waiting for wide

24、 moats to become cheap is a compelling strategy. Wide + CheapReturns through 9/18/2021 * Annualized returns Source: MorningstarYTDTrailing1-YearTrailing3-Year*Trailing5-Year*Morningstar Wide Moat Focus Index (ETN Ticker: WMW)41.6%9.3%6.0%9.0%S&P 500 Index20.5%-9.1%-4.8%1.0%The Wide Moat Focus is an index of our 20 most undervalued wide-moat stocks. Holdings are equally-weighted and re