Morningstar's Moats

12/12/2003 12:00 am EST


Mark Sellers

Editor-in-Chief, Morningstar StockInvestor and FundInvestor

"What's the difference between a good company and a great one?" asks Mark Sellers, editor of  Morningstar StockInvestor. "Any firm that hopes to protect shareholder capital over the long term needs to build an ‘economic moat’ around itself in order to shield its core business from competitors." Here, he highlights ten stocks with "super-wide" moats.

"Morningstar assigns each company we cover a rating that describes the size of its economic moat: wide, narrow, or none. Wide-moat companies are those that have strong, sustainable competitive advantages and high returns on capital. In our monthly newsletter, Morningstar StockInvestor, we track a watch list of 50 companies with wide economic moats called the Bellwether 50. These companies have large competitive advantages and are typically found in mature, stable industries such as data processing, healthcare, and consumer products. We've identified four main types of economic moat. Companies possessing one or more of these traits typically have a moat that allows them to generate high returns on capital. For that reason, they're typically awarded high price/earnings ratios by the market.

"Our moat ratings are more of an art than an exact science. No specific financial ratios or footnotes in a 10-K filing will tell us definitively whether a company has a wide moat. For that reason, we classify moats into three broad categories that give a rough idea of their size (wide, narrow, or none), rather than, say, on a scale of one to 10. To quote Warren Buffett, it's better to be approximately right than exactly wrong. There's also a short list of companies with such obvious competitive advantages it doesn't take much deliberation at all to assign them a wide-moat rating. These companies are exceedingly rare; there are probably not more than a handful of them out of the 8,000 publicly traded firms in our database. If we had a fourth category for ‘super-wide moat,’ these 10 companies would almost certainly qualify:

  1. Wal-Mart (WMT NYSE): Wal-Mart is the low-cost grocer it can charge 15% less for food than traditional grocery stores because of its distribution efficiency and lower labor costs.
  2. Bershire Hathaway (BRK.B  NYSE): Because of its financial strength, Berkshire has access to capital at a lower cost than any other company on the planet, which is just one of its many competitive advantages.
  3. Coca-Cola: (KO NYSE): We like many aspects of Coca-Cola, including its powerful brands, marketing might, and well-established global-distribution systems.
  4. Anheuser-Busch (BUD NYSE): This beer behemoth operates on a scale unrivaled by competitors. This, along with the firm's commitment to cost-containment, has provided consistent gross-margin improvements year after year.
  5. Wrigley (WWY NYSE): Wrigley is the dominant chewing gum maker in the world, with a US market share greater than 50%, and 80% share in parts of Europe.
  6. Moody’s (MCO NYSE): Moody's business has high barriers to entry and fat profit margins, requires low capital investment, and has solid growth prospects. It also has a shareholder-friendly management team.
  7. Paychex (PAYX NASDAQ): Paychex has low-capital investment needs. The investments it does make are in data-processing equipment and software, the costs of which tend to decline over time. Thus, margins keep expanding as the company grows.
  8. Sysco (SYY NYSE): With $23 billion in annual sales and more than 400,000 customers spread across the United States and Canada, Sysco boasts economies of scale unparalleled in the highly fragmented food wholesale industry.
  9. eBay (EBAY NASDAQ): The major reason for eBay's dominance is the network effect: All the buyers go to eBay because that's where all the sellers are, and all the sellers go there because that's where all the buyers are. And with more than 60 million registered users, eBay's network is very big indeed. 
  10. Automatic Data Processing (ADP  NYSE): A sterling record of growth, strong competitive positions in its markets, and a fortress-like balance sheet make ADP a rare company."
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