This article is part of Morningstar’s Guide to Your Financial Education, providing our readers with the tools they need to become a successful private investor.
As physical moats protect castles from enemies, economic moats are structural advantages that protect companies from competitors. Through our proprietary research of over a thousand companies, we have identified five major moat sources: intangible assets, cost advantage, switching costs, network effect, and efficient scale. These moats – or competitive advantages – can be the key to successful stock selection.
Wide-moat stocks, bought at the right price, are the sorts of structurally sound businesses, or “steady-eddies”, savvy investors look to own at the core of their portfolio. Around these reliable stocks you can build out a balanced and diversified investment portfolio.
Using share database Morningstar Select we identified three companies with a large competitive advantage over their peers – assigned a “wide moat” status by Morningstar equity analysts. Like all companies, these shares are only a buy at the right price, but their wide moats give them fantastic long-term potential.
ARM Holdings (ARM)
ARM Holdings licenses microprocessor intellectual property and silicon physical layer designs and provides related development software and technologies, which support applications in mobile devices, automobiles, and other electronic products.
We believe ARM Holdings' wide economic moat stems from intangible assets around its library of IP for processor designs used in handsets and other electronic devices, as well as switching costs associated with ARM's ecosystem of partners.
We think few firms would have the wherewithal to internally develop the intangible assets needed to build a similar library of designs based on chip performance, size, and power consumption, which significantly raises the bar for competition.
British American Tobacco (BATS)
British American sells tobacco products in 180 countries and holds leadership positions in around 50 of its markets.
Powerful intangible assets are at the core of British American Tobacco's wide economic moat. In addition, the company's platform of total tobacco products and e-cigarettes gives the firm economies of scope and scale that make it difficult for new entrants to gain the critical mass of volume necessary to compete.
Finally, the addictive nature of tobacco products makes demand fairly price inelastic, and with few substitute products outside the portfolios of the Big Tobacco firms, a favorable industry structure exists for the largest players which creates, for the most part, an environment of rational pricing.
Unilever (ULVR)
Unilever Group is a diversified packaged food, and household and personal product company. Morningstar analysts assign Unilever a wide moat due to the strength of its brand portfolio and its vast scale, which would be costly to replicate. Unilever is the third-largest packaged food firm in the world and one of the largest global household and personal product firms, with its top 13 brands each generating more than €1 billion in annual revenue.
