Specifically, the Morningstar Moat Focus Indices target companies with a wide economic moat or sustainable competitive advantages and focuses on the most undervalued moat stocks, which have helped generate significant excess returns relative to the overall market.
According to Morningstar’s indexing methodology, there are five sources of economic moats: Intangible assets that include brand recognition to charge premium prices. Switching costs that make it too expensive to stop using a company’s products. Network effect that occurs when the value of a company’s service increases as more use the service. A cost advantage helps companies undercut competitors on pricing while earning similar margins. Lastly, efficient scale associated with a competitive advantage in a niche market.
“Capitalism works,” Michael Hodel, Technology Strategist at Morningstar, said. “High profits attract competition. Competition reduces profitability, but some firms stay very profitable for a long time by creating economic moats to protect profits.”
Hodel also added that the Wide Moat Focus and Global ex-US Moat Focus indices track “high quality companies trading at a discount to intrinsic value.” Moreover, the Morningstar Moat Focus targets wide moat companies that may sustain economic profits for at least 20 years, whereas a narrow moat company would only be able to sustain profits for about 10 years.
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