Warren Buffett coined the term “economic moat” to refer to anything that insulates a company from competition, explains Kuen Chan in The Complete Investor.
Companies with a wide economic moat — because of a strong brand name, clearly superior products, a low cost structure, or any other significant advantage — have a big edge in maintaining long-term profitability and market share.
Seizing on this concept, Morningstar created the Wide Moat Focus Index. It consists of the 20 US stocks deemed to best combine a wide economic moat and market undervaluation.
The Market Vectors Morningstar Wide Moat ETF (MOAT) track the index, giving investors an easy way to own these wide-moat paragons.
Seventeen of the 20 holdings have market caps above $10 billion, including five with market caps of $100 billion or higher.
The large-cap bias makes sense, since to meet Morningstar’s criteria, a company would have had time to grow in size and generate the resources needed to create a wide moat.
Because of their large size, they’re not considered very-high-growth companies, but this doesn’t mean they’re not growing; rather, it speaks to their reasonable multiples.
So far in 2016, MOAT has easily outperformed the S&P 500. The ETF now heavily overweight healthcare, which accounts for eight of the 20 stocks.
The Morningstar team clearly sees value in the sector after fears about government price controls dragged down many high-quality health care stocks.
The eight include two Gilead (GILD) and Biogen (BIIB). Both own blockbuster drugs with best-in-class efficacy: Gilead’s treats hepatitis C, while Biogen’s drug is for multiple sclerosis.
The other six are biotech company Amgen (AMGN), big pharma Allergan (AGN), pharmacy benefits manager Express Scripts (ESRX), health care supplier and IT service provider McKesson (MCK), medical equipment specialists St. Jude Medical (STJ) and Varian Medical Systems (VAR).
Next up are seven financial stocks. While we’re not generally fans of investing in banks, only three are actually banks: State Street (STT), USB Bank (USB), and Bank of NY Mellon (BK), all of them relatively high quality.
The other four financial stocks include payment processors Visa (V), MasterCard (MA), which together account for more than 80 percent of global debit and credit card transactions, CBRE Group (CBG) and Jones Lang LaSalle (JLL), two leading providers of niche real-estate services.
Also in the ETF are railroad stocks Norfolk Southern (NSC) and CSX (CSX). The drop in commodity prices hurt rail companies, creating good buying opportunities.
The final three stocks are Disney (DIS), LinkedIn (LNKD) and Monsanto (MON). MOAT charges an annual fee of 0.49 percent.
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By Kuen Chan of The Complete Investor.
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