Finance
by Heather Brilliant and Elizabeth Collins
How long can high profits last?
When a business earns high profits, rivals pile in to take them. Heather Brilliant and Elizabeth Collins, who led research teams at Morningstar, explain how its analysts judge which companies can hold off competitors for years, and why that matters to anyone buying shares.
Hear a sample · read by Laura
Warren Buffett compared a great business to a castle protected by a moat. Morningstar turned the image into a rating. A moat is a lasting advantage that lets a company earn returns on capital above its cost of capital for years. Without one, competition wears those returns down.
Morningstar's analysts look for five sources. Intangible assets, such as brands, patents and licences. Switching costs that make customers stay. The network effect, where more users make a product more useful. Cost advantage. And efficient scale, where a market only has room for a few players.
Morningstar rates each company's moat. Wide means its analysts are confident the excess returns will last at least ten years, and think they'll more likely than not last twenty. Narrow means they'll more likely than not last ten. No moat means competition should wear them away sooner.
Morningstar also rates which way a moat is heading, as positive, stable or negative. An advantage can be eroding long before profits show it. The authors treat the trend as an early warning, and as a way to spot moats that are still being dug.
A great moat doesn't make a share a bargain. Morningstar's analysts estimate what each company is worth and look for a price well below it, demanding a bigger discount when the future is harder to predict. The authors pair the moat rating with this fair value estimate.
The moat
A moat is a lasting edge that lets a company keep earning high returns while rivals try to catch up.
Intangibles
Brands, patents and licences can keep rivals out, but only if they let the company charge more.
Switching costs
When leaving is a pain, customers stay even if a rival is a bit cheaper.
Network effect
Some services get more useful as more people use them, which makes them hard to beat.
Cost advantage
A company that makes things more cheaply than anyone else can undercut rivals and still profit.
One thing to try
Pick three companies whose products you use every week. For each, name which of the five sources protects it, if any. Would you switch to a slightly cheaper rival tomorrow? If you would, and no source fits, the company may have no moat at all.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. Why Moats Matter comes with a Name That Idea round to make it stick.
Get the whole book on KnotdOpen in the appHow long can high profits last? When a business earns high profits, rivals pile in to take them. Heather Brilliant and Elizabeth Collins, who led research teams at Morningstar, explain how its analysts judge which companies can hold off competitors for years, and why that matters to anyone buying shares.
The castle and its moat; Five sources of moat; Wide, narrow or none; Watch the trend; A moat has a price.
Pick three companies whose products you use every week. For each, name which of the five sources protects it, if any. Would you switch to a slightly cheaper rival tomorrow? If you would, and no source fits, the company may have no moat at all.
Yes. Knotd has the key ideas from Why Moats Matter in a few minutes, in plain words, plus a Name That Idea round to test them. It's one of 250+ non-fiction books in the app.
