History of moats: From ancient castles to modern markets


The role of moats has changed since they were first built centuries ago to protect townships. But in business, their role remains the same as their original purpose: protection.

There is evidence that the Ancient Egyptians were the first people to use moats to protect castles. The most famous example is in Buhen, which is now submerged in Lake Nubia, Sudan. Around 4,000 years ago it was a thriving copper producing city on The Nile’s West Bank. A fortress was built in Buhen during the rule of Senusret the Third, who many biblical scholars believe elevated Joseph to be his vizier (Joseph, you may recall had a coat of many colours). This fortress included a water-filled moat three meters deep. The structure had drawbridges, ramparts and battlements which were all built with the intention of fortifying the small town within its walls.

These ancient Egyptians built a moat with the intention of warding off invaders. Later in Medieval Europe, deep and broad ditches were built around castles and towns to provide defence against attacking armies. Moats made access to the walls of the castle difficult for siege weapons such as battering rams and catapults. Those moats which were the widest offered the best defence.

Later, the development of firearms led to new principles of design for protection, but moats were often still used to provide effective barriers to entry. Here in Australia, the Queensland government built Fort Lytton in the late 19thCentury on advice from the British who feared a French or Russian naval invasion. It is the only moat fort ever built in Australia. And it must have worked, because the French or Russians never did invade!

Moats just as important today

Today’s moats may not be effective against modern warfare technology, but that is not to say that moats are not important. You just need to understand how they can help in the battlefield of businesses.

While we no longer protect our towns and important buildings with moats, some companies have been building structural sustainable competitive advantages that protect their businesses. These are the ‘moats’ of the new world.

The moat metaphor has been attributed to Warren Buffett. The Wall Street Journal reported in 2012 that “Warren Buffett has used the term 20 times since 1986 to describe his investment process in annual letters to Berkshire Hathaway shareholders.”

The moat concept addresses whether a business has earnings and characteristics that make it difficult for competitors to attack its 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 high returns over a long period in the future.

Morningstar has identified as five potential sources of an economic moat: network effect; intangible assets; cost advantage; switching costs; and efficient scale. Each company with a moat rating has at least one, if not two, of these moats.

Sources of Moats
Switching Costs
Switching costs give a company pricing power by locking customers into its unique ecosystem. Beyond the expense of moving, they can also be measured by the effort, time, and psychological toll of switching to a competitor.
Intangible Assets
Though not always easy to quantify, intangible assets may include brand recognition, patents, and regulatory licenses. They may prevent competitors from duplicating products or allow a company to charge premium pricing.
Network Effect
A network effect is present when the value of a product or service grows as its user base expands. Each additional customer increases the product’s or service’s value exponentially.
Cost Advantage
Companies that are able to produce products or services at lower costs than competitors are often able to sell at the same price as competition and gather excess profit, or have the option to undercut competition.
Efficient Scale
In a market limited in size, potential new competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital.

Of the thousands of companies globally, Morningstar analysts have only assigned a wide moat rating to just over 200 of these. These are the companies Morningstar analysts identify as being able to sustain their high returns, more likely than not, for at least 20 years.

Morningstar’s analysis does not stop with its moat rating. Morningstar’s equity analysts also 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.

Using a combination of the qualitative moat data and the quantitative fair value data, Morningstar constructs its Wide Moat Index series. Morningstar targets companies whose stock is trading below its estimate of the fair value when it constructs its Wide Moat Indices. ETFs which track these indices offer investors a portfolio of wide moat companies in a single trade on ASX.

There are two ETFs Australian investors can invest in which include companies that have built wide moats to protect their businesses from competitors:

  1. For international equities: VanEck Morningstar World ex Australia Wide Moat ETF (ASX: GOAT)
  2. For US equities: VanEck Morningstar Wide Moat ETF (ASX: MOAT)

Find out more about moat investing or learn more about ETF investing with VanEck Australia. 

Published: 18 September 2020

Important notice

Issued by VanEck Investments Limited ACN 146 596 116 AFSL 416755 (‘VanEck’). This is general advice only, not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Read the PDS and speak with a financial adviser to determine if the fund is appropriate for your circumstances. PDSs are available here and details the key risks. No member of the VanEck group of companies guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from the fund.

An investment in GOAT or MOAT carries risks associated with: financial markets generally, individual company management, industry sectors, ASX trading time differences, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations and tracking an index. See the PDS for details.

The Morningstar® Wide Moat Focus Index™ and the Morningstar® Developed Markets ex-Australia Wide Moat Focus Index™ (‘the Morningstar Indices’) are created and maintained by Morningstar, Inc. Morningstar, Inc. does not sponsor, endorse, issue, sell, or promote the funds and bears no liability with respect to the funds or any security. Morningstar®, the Morningstar Indices and Morningstar Economic Moat™ are trademarks of Morningstar, Inc. and have been licensed for use by VanEck.