The Morningstar Economic Moat Rating methodology assign an economic moat rating to companies, but it also focuses on those that show attractive valuations or are more attractively priced. Beyond factor effects, stock selection is also an important driver as the underlying indices combine both quality and valuation to help investors potentially generate improved returns.
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.
An investor would end up with the most attractively priced stocks among the companies that have garnered the “wide moat” rating.
Financial advisors who are interested in learning more about the smart beta strategy can register for the upcoming Tuesday, November 6 webcast here.