uploads/2017/05/PART-1-1ST-1.jpg

How Does Moat Investing Provide a Competitive Advantage?

By

Updated

VanEck

Performance Overview

The U.S.-oriented Morningstar® Wide Moat Focus IndexSM (MWMFTR, or “U.S. Moat Index”) posted strong returns in April and outpaced the S&P 500® Index (1.97% vs. 1.03%). The U.S. Moat Index extended its outperformance of the S&P 500 Index to nearly 3.00% for the year-to-date period (10.12% vs. 7.16%). International moat stocks, as represented by the Morningstar® Global ex-US Moat Focus IndexSM(MGEUMFUN, or “International Moat Index”), performed mostly in line with the MSCI All Country World Index ex USA for the month (1.97% vs. 2.14%), but maintained their outperformance gap for YTD 2017 (13.26% vs. 10.17%).

Article continues below advertisement

Market Realist

How firms obtain economic moat ratings

Morningstar, with its fundamental approach to investing, helps investors identify and choose companies with economic moats. “Economic moats” is a term coined and popularized by Warren Buffett. It refers to companies’ ability to obtain a competitive advantage over competitors. Morningstar identified two requirements for companies to obtain economic ratings of “narrow” or “wide.” Companies have to earn above-average returns on capital and prevent returns from wearing down quickly.

To obtain a “narrow” or “wide” economic moat rating, firms must hold some competitive advantage over their competitors, which helps them create long-term value for shareholders and higher returns for investors. The above chart shows the five sources of obtaining a competitive advantage or economic moats.

Article continues below advertisement

Morningstar moat indices outperformed in April

Since President Trump was elected, the US economy has seen a turnaround. With the improving economy, the S&P 500 Index (SPY) (IVV) has been rising—it has delivered 7.9% year-to-date. According to Factset, S&P 500 companies saw earnings growth of ~14% YoY (year-over-year) in 1Q17—the highest YoY earnings growth for the index since 3Q11. However, the Morningstar Wide Moat Focus Index or the U.S. Moat Index (MOAT) outperformed the S&P 500 Index in April and YTD, as shown in the following charts. The index provides exposure to UD stocks that have a wide moat rating and trade at a discount to Morningstar analysts’ fair value estimates.

On the other hand, the Morningstar Global ex-US Moat Focus Index (MOTI) or the international moat index’s performance in April was almost at par with the MSCI All Country World Index (ACWI) while outperforming on a YTD basis. The index provides exposure to non-US quality stocks in developed and emerging markets with a “wide” or “narrow” moat rating that trade at an attractive price. Moat indices’ outperformance was led by carefully chosen companies with a sustainable competitive advantage.

In the next part, we’ll discuss which companies were the leaders and laggards in the Morningstar moat indices’ performance for April 2017.

Advertisement

More From Market Realist