In business, I look for economic castles protected by unbreachable 'moats' - Warren Buffett

In days of old, a castle was protected by the moat that encircled it. The wider the moat, the more easily a castle could be defended. A narrow moat would not offer much protection and would allow enemies easy access to the castle. To Buffett, the castle is the business and the moat is the competitive advantages of the company.

Economic moats are sustainable competitive advantages that allow companies to protect their value and to generate excess returns. It is one thing for a company to be successful at the moment. The question is whether the business has characteristics that make it difficult for competitors to attack those earnings.

Building on Buffett’s Moat analogy, Morningstar® has taken the economic moat concept a step further and developed a comprehensive moat-based analytic framework.

A company may have great management, size, market share, technology, efficiencies or hot products but what Morningstar identifies is whether the company has a structural advantage that can sustain the high returns over a long period in the future.

Only the top 20 most attractively priced US ‘wide-moat’ companies which Morningstar considers to have competitive advantages that are sustainable for over 20 years are captured in the Morningstar Wide Moat Focus Index™. Van Eck Global recently listed on ASX its Market Vectors Morningstar Wide Moat ETF (ASX code: MOAT). MOAT seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Morningstar Wide Moat Focus Index.

Evaluating economic moats is a qualitative process. Morningstar classify moats as either wide, narrow or none. To determine which bucket a company fits into, Morningstar analysts spend a lot of time getting to know industries, combing through financial statements and talking to management. Morningstar will only classify a company's moat as wide if there is evidence that structural advantages have delivered above-average returns on capital over an extended period of time.

The hurdle is high for earning a wide moat rating. Despite scouring the universe of 1,500 listed US companies, Morningstar have only assigned wide moat ratings to approximately 150 companies. But Morningstar does not stop there.

Morningstar’s equity analysts assign a fair value to each company in its coverage universe. Fair value is a per-share measure of what the business is worth. A three-stage discounted cash flow model is combined with a variety of supplementary fundamental methods such as sum-of-the-parts, multiples, and yields in order to triangulate a company's worth.

Morningstar targets companies whose stock is trading below its estimate of the fair value. When compiling the Morningstar Wide Moat Focus Index they include only the 20 most compelling valuations from those US companies who have wide moats. The index is a rules based, equal weighted index reviewed quarterly.

The long term returns from applying this process to US equities outperform the broad market index.

Source: Morningstar; FactSet. Performance is in Australian dollars.
Performance data quoted represents past performance. Past performance is not a guarantee of future results. Index performance is not illustrative of fund performance. Prior to April 24, 2012, Market Vectors Morningstar Wide Moat ETF had no operating history. Indices are unmanaged and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a fund. Indices are not securities in which investments can be made.

Buffett said it best in a 1999 Fortune article: "The key to investing is ... determining the competitive advantage of any given company and, above all, the durability of that advantage." The charts above validate Morningstar’s strategy to use companies’ competitive advantages to select stocks. Morningstar’s equity research team has demonstrated a strong ability to identify both economic moats and underpriced stocks.

For more information on MOAT click here.

To speak to a Market Vectors ETF specialist please call us on 02 8038 3300 or send an email to info@marketvectors.com.au

IMPORTANT NOTICE: Issued by Market Vectors Investments Limited ABN 22 146 596 116 AFSL 416755 (‘MVIL’). MVIL is a wholly owned subsidiary of Van Eck Associates Corporation based in New York, United States (‘US’) (‘Van Eck Global’). Market Vectors ETF Trust ARBN 604 339 808 (‘MVET’) is the issuer of shares in the Market Vectors Morningstar Wide Moat ETF (‘US Fund’). MVET and the US Fund are regulated by US laws which differ from Australian laws. Trading in the US Fund’s shares on ASX will be settled by CHESS Depositary Interests (‘CDIs’) which are also issued by MVET. MVET is organised in the State of Delaware, US. Liability of investors is limited. Van Eck Global serves as the investment adviser to the US Fund.

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