As some may know, Morningstar currently has a Wide Moat Focus Index that “consists of the 20 securities in the Morningstar US Market Index with the highest ratios of fair value… to their stock price, and which have a sustainable competitive advantage…”
For those persuaded by the idea that some businesses have wider economic moats, but without the time or desire to go looking for them, the Index provides the investor with twenty places to start. As of 2/27/2009, the Index included Monsanto Company, Waters Corporation, Starbucks Corporation, Maxim Integrated Products, Fastenal Company, Zimmer Holdings, Applied Materials, Paychex, IMS Health, Forward Air Corporation, The Western Union Company, KLA-Tencor Corporation, Avon Products, eBay, International Speedway, St. Joe Corporation, Autodesk, American Express, Legg Mason, and Bank of America.
Even more useful is Morningstar’s description of their methodology for selecting the favored twenty. First, a business must pass the “show me the money” test, which demands that its return on invested capital (ROIC) has consistently exceeded its cost of capital. Having satisfied this initial screen, Morningstar analysts then assess whether the margin can be attributed to a clear competitive advantage. Morningstar classifies four major types of competitive advantage: high switching costs (e.g., Stryker), lower general costs (e.g., Wal-mart), valuable intangible assets (e.g., Harley-Davidson), or a sufficiently large network of users (e.g., eBay, NYSE).
Stryker benefits from high switching costs because surgeons that use their products would have a difficult time retraining their habits and skills to efficiently use a competitor’s. Wal-mart sells a wide array of basic consumer goods that could be purchased in numerous locations; that is, its products are practically indistinguishable—essentially commodities. In a commodity business, the only lasting advantage is being the perennial lowest cost producer, and in retailing that’s Wal-mart; in car insurance, Geico. Harley Davidson offers a product that its customers will pay a premium for (and then profess their undying love through abundant bodily art). eBay’s network of buyers and sellers offers each an optimal market experience; buyers find a rich selection, and sellers can solicit the largest number of buyers and presumably the highest prices.
Looking over Morningstar’s favored twenty, a couple businesses stand out. First, and perhaps with the benefit of hindsight, it is hard to imagine a retail bank like Bank of America with a sustainable economic moat. The little brick retail banks reign in ubiquity in our town, all seemingly offering similar rates and services. Though it may have been inconvenient to set up banking accounts in the past, online platforms have surely simplified the process.
American Express is also an interesting case. While swiping an AMEX used to carry some cache, today it is mere French vanilla. While American Express does have its credit card network, by sheer numbers, Visa’s and Mastercard’s stand superior.
All told, Morningstar’s Index highlights some interesting businesses for the wide moat investor. We’ll take a deeper look at some in the weeks ahead.
Disclosure: I, or persons whose accounts I manage, own shares of eBay at the time of this writing.