Intangible Assets are the Leading Source of Moats

"How Moats Translate into Sustainable Competitive Advantages" is a five-part moat investing education series that explores the primary sources of economic moats. The idea of an economic moat refers to how likely a company is to keep competitors at bay for an extended period. According to Morningstar Equity Research, there are five key attributes that can give companies economic moats, and which are viewed as sources of sustainable competitive advantages: 1) Network Effect; 2) Intangible Assets; 3) Cost Advantage; 4) Switching Costs; and 5) Efficient Scale. Here we explore the concept of "Intangible Assets."

Intangible Assets help build strong, identifiable advantages

Although not always easy to quantify, intangible assets are one of the primary sources of strong competitive advantages for businesses and a key source of economic moats. Intangible assets can include corporate intellectual property, such as patents, trademarks, copyrights, government licenses, and business methodologies. Intangible assets help companies to safeguard key competitive advantages. Companies can use patents, for instance, to protect inventions from unauthorised commercial usage by competitors. Like patents, government licenses also raise the entry hurdles for new competitors.

A company's reputation, often measured by goodwill and brand recognition, is also considered an intangible asset. Brand identities play a key role in helping companies to stay ahead of competitors, and simply put, a positive brand promotes sales, builds trust, and inspires customer loyalty.

According to Morningstar equity research, nearly 60% of its moat-rated companies have achieved this recognition because of intangible assets defined by Morningstar Research as:

Intangible Assets. Patents, brands, regulatory licenses, and other intangible assets can prevent competitors from duplicating a company's products, or allow the company to charge a significant price premium. For example, patents protect the excess returns of pharmaceutical manufacturers such as Novartis NVS. When patents expire, generic competition can quickly push the prices of drugs down 80% or more.

Economic Moat
Five Sources of Sustainable Competitive Advantage

Source: The Morningstar^® Economic Moat^™ Rating System.

Intangible Assets in action: Four case studies of moat companies

To demonstrate the power of intangible assets in creating economic moats, we highlight two US wide moat companies, big pharma Bristol-Meyers Squibb and home-improvement retailer Lowe's. 

Bristol-Meyers Squibb Company (BMY US) holds a "wide economic moat" rating from Morningstar, based on its extensive list of patent-protected drugs, global sales force, and economies of scale. Morningstar Research explains that BMY's patent protection "allows the company to price its drugs at levels that translate into superior returns on invested capital compared with its cost (particularly in cancer drugs, a focus for Bristol)." BMY's patents are a strong intangible asset and provide it with plenty of lead time to research and introduce next generation new drugs. Bristol boasts a strong distribution channel and sales force, which help it to partner with smaller drug companies to gain access to externally created drugs. Finally, Bristol benefits greatly from its brand identity, its sheer size and a healthy balance sheet with ample cash.

Lowe's Companies (LOW US) is the second-largest global home-improvement retailer (behind Home Depot). Morningstar Research gives Lowe's a "wide economic moat" rating based on the company's low-cost position, but the company also benefits from several intangible assets. "The business has been built on customer service, knowledge, and innovation, which are top notch in the home-improvement business." Lowe's also has competitive advantages based on its information technology platform and distribution network, which are key differentiators. The firm has created an integrated supply chain that efficiently routes nearly 80% of all Lowe's merchandise through one of 15 regional distribution centers. Finally, Lowe's strength in logistics and scale generates significant bargaining power with vendors.

VanEck Vectors Morningstar Wide Moat ETF (MOAT) provides access to US moat-rated companies, by seeking to track the Morningstar^® Wide Moat Focus Index^SM . The index measures the overall performance of attractively priced companies with sustainable competitive advantages in their respective markets according to Morningstar's equity research team.

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