Moat Focus Index has been performing well vs. the S&P 500. Imagine how large the difference would be if we extracted all the wide moat businesses from the S&P 500.
The concept of a moat has been talked about by many great investors for several decades. But if successful investing was as easy as investing in a company with an economic moat, everyone would do it!
An important caveat to the discussion of moats is whether the moat is protecting something valuable. A company with a moat is valuable if the moat is protecting an ABOVE AVERAGE business. What do I mean by an above-average business? A business that can produce high returns on capital. This means that for EVERY dollar invested into the business, we get at least 15 cents out of our invested dollar. This represents a 15% return on capital invested. Additionally, there must be room for reinvestments, as this will compound our capital at these above-average rates.
There are several other traits we want to see in a business that I won’t go into in this article. But the bottom line is that a moat is only valuable if it protects a unique business that is producing above-average returns. Having a moat around 6-7% annual returns is nice for the business owner, but not if you want to achieve market-beating results.
Companies with strong moats outperform
Studies conducted by Morningstar confirm that wide and narrow moat businesses outperform those businesses that do not have a moat. This is logical as no-moat businesses are usually in highly competitive markets with low barriers to entry. In these markets, the profits and above-average returns get competed away, leaving what we call a “red ocean” filled with competition. Competition is not good for us as investors as it promotes activities such as price cutting, which in turn affects margins and profits.
As we can see from the image above a wide moat companies are able to keep their margins and ROIC higher than those businesses without a moat. By definition, companies with a moat will be a higher quality business than those without and deserve a higher PE multiple.
The strongest Moat Source is Network Effects
Reviewing research, we can see that the topic of “the best moat” has been researched extensively. In their study, Network effects scored best in terms of 5 and 10-year stock price CAGR. It is also worth mentioning that Intangible assets score second highest on the 10-year CAGR, followed closely by Switching costs. While Efficient scale and Cost Advantage scores are lower compared to the other moat sources.
The point to get from this is that moats will allow a business to protect its above-average business from competitors. It is far better to have an economic moat than to not have one. Therefore, it is an important part of our jobs as quality investors to assess the strength of a moat, and whether or not it is increasing or decreasing in strength over time.
10 Wide Moat Businesses 👑
Now, let’s take a look at 10 prime examples of wide-moat businesses that are protecting an above-average business. Notice that many of these businesses are growing and expanding their return on capital at the same time, indicating that they can widen their advantage over time. Others have seen a reduction in return on capital and margins, in most cases, this is due to M&A activity (Example: S&P Global).
$Visa(V)$
$Apple(AAPL)$
$LVMH-Moet Hennessy Louis Vuitton(LVMHF)$
$Costco(COST)$
$Copart(CPRT)$
$Old Dominion Freight Lines(ODFL)$
$Moody's(MCO)$
$Microsoft(MSFT)$
$S&P Global(SPGI)$
$MasterCard(MA)$
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