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Why Moats Matter: The Morningstar Approach to Stock Investing [Hardcover]

Heather Brilliant , Elizabeth Collins

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Book Description

22 Aug 2014
Incorporate economic moat analysis for profitable investing Why Moats Matter is a comprehensive guide to finding great companies with economic moats, or competitive advantages. This book explains the investment approach used by Morningstar, Inc., and includes a free trial to Morningstar′s Research. Economic moats—or sustainable competitive advantages—protect companies from competitors. Legendary investor Warren Buffett devised the economic moat concept. Morningstar has made it the foundation of a successful stock–investing philosophy. Morningstar views investing in the most fundamental sense: For Morningstar, investing is about holding shares in great businesses for long periods of time. How can investors tell a great business from a poor one? A great business can fend off competition and earn high returns on capital for many years to come. The key to finding these great companies is identifying economic moats that stem from at least one of five sources of competitive advantage—cost advantage, intangible assets, switching costs, efficient scale, and network effect. Each source is explored in depth throughout this book. Even better than finding a great business is finding one at a great price. The stock market affords virtually unlimited opportunities to track prices and buy or sell securities at any hour of the day or night. But looking past that noise and understanding the value of a business′s underlying cash flows is the key to successful long–term investing. When investors focus on a company′s fundamental value relative to its stock price, and not where the stock price sits today versus a month ago, a day ago, or five minutes ago, investors start to think like owners, not traders. And thinking like an owner will makes readers better investors. The book provides a fundamental framework for successful long–term investing. The book helps investors answer two key questions: How can investors identify a great business, and when should investors buy that business to maximize return? Using fundamental moat and valuation analysis has led to superior risk–adjusted returns and made Morningstar analysts some of the industry′s top stock–pickers. In this book, Morningstar shares the ins and outs of its moat–driven investment philosophy, which readers can use to identify great stock picks for their own portfolios.


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From the Inside Flap

Just as physical moats protect castles from enemies, economic moats—or sustainable competitive advantages—protect companies from competitors. Legendary investor Warren Buffett devised the economic moat concept. Morningstar has made it the foundation of a successful stock-investing philosophy. At Morningstar, we've always viewed investing in the most fundamental sense: We want to hold shares in great businesses for long periods of time. How can you tell a great business from a poor one? A great business can fend off competition and earn high returns on capital for many years to come. The key to finding these great companies is identifying economic moats that stem from at least one of five sources of competitive advantage—cost advantage, intangible assets, switching costs, efficient scale, and network effect—each of which we explore in great depth. Even better than finding a great business is finding one at a great price. The stock market affords virtually unlimited opportunities to track prices and buy or sell securities at any hour of the day or night. But looking past that noise and understanding the value of a business' underlying cash flows is the key to successful long-term investing. When you focus on a company's fundamental value relative to its stock price, and not where the stock price sits today versus a month ago, a day ago, or five minutes ago, you start to think like an owner, not a trader. And thinking like an owner will make you a better investor. As you've probably guessed, this book won't tell you how to get rich quick by juggling stocks. What it will give you is a fundamental framework for successful long-term investing. The book will help you answer two key questions: How can I identify a great business, and when should I buy that business to maximize my return? If you get these two things right more often than not, you're well on your way to investing success. Ours is not the only valid method for investing in stocks, but it's one that has worked well over the years. Using fundamental moat and valuation analysis has led to superior risk-adjusted returns and made Morningstar analysts some of the industry's top stock-pickers. In this book, we share all the ins and outs of our moat-driven investment philosophy, which you can use to identify great stock picks for your own portfolio. To find out more about Morningstar's approach to stock investing and receive a free trial of our research, visit: www.global.morningstar.com/whymoatsmatter

From the Back Cover

"The search for the enduring economic moat is the holy grail of value investing. These modern–day protected business castles allow their owners to earn high returns on capital, the ultimate goal for any long–term investor. In Why Moats Matter , Heather Brilliant and Elizabeth Collins provide a wonderfully detailed map to help both small and large investors find these great companies." —John W. Rogers Jr. , founder, chairman, and chief investment officer, Ariel Investments "Morningstar′s Economic Moat framework is a useful complement to Michael Porter′s five forces model, as it approaches the issue of franchise quality from an investor′s perspective. Armed with Morningstar′s moat framework, I′ve been able to make better assessments of companies′ competitive positions, which is a critical element of my stock–picking process." —Michael Luciano , investment analyst and U.K. pilot fund manager, Fidelity Worldwide Investment

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Front Cover | Copyright | Table of Contents | Excerpt | Index | Back Cover
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Amazon.com: 4.3 out of 5 stars  7 reviews
3 of 3 people found the following review helpful
4.0 out of 5 stars Moats plus Margin of Safety equals returns 25 Aug 2014
By investingbythebooks - Published on Amazon.com
Format:Hardcover
In a capitalistic economy with free market entry new competition will ensure that any existing company’s surplus financial returns will evaporate over time. That is, unless there is something that interferes and protects the incumbents from new competition. Few have spent more time thinking of sustainable incumbent competitive advantages – or moats in Warren Buffett’s parlor – than the independent investment research firm Morningstar. In fact the firm has built its entire research process around the two building blocks moats and margin of safety. The credited authors are co-CEO of Morningstar Australasia and Director of Equity Research in North America respectively, but a large number of Morningstar staff have contributed to the book.

Why Moats Matter implicitly has two parts. The first is a detailed run through of Morningstar’s equity research methodology – complete with an ending quantative back test showing that their undervalued stocks in companies with wide moats generate excess returns. The second is a one-by-one description of the moat in a number of industries. The authors’ stated goal is to provide the reader with the means to determine a company’s moat and margin of safety, to use in his own investment decision-making. Perhaps the less clearly stated goal is to advertise the merits of Morningstar’s research? Sell side equity research is a tough business and it’s not easy to compete with the Goldman Sachses of this world. The structure of the book certainly opens up for the risk that it becomes a (lengthy) promotional leaflet.

As I like Morningstar’s approach I might be biased, but I don’t think that the book crosses the “ad-brochure-line”. Also, even if it doesn’t exactly sparkle it’s not as dry as you might expect of a book on research methodology. I appreciate that Morningstar looks at the right things such as “moat trends” or the level of uncertainty of their intrinsic stock valuations (demanding a larger margin of safety to rate it a buy if they feel less sure) and that they systematize intangible factors into actionable grading systems in a way that differentiates them from the bulge bucket research. Five sources of economic moats are identified: 1) Intangible Assets such as brands or patents, 2) Cost Advantages due to for example economies of scale, 3) Switching Costs where the customers finds it expensive or inconvenient to change supplier, 4) Network Effects created by positive loops from growing number of users and 5) Efficient Scale where rational new entrants are kept out of an industry as their entry would destroy the market – also for themselves.

Why Moats Matter is in a way a sequel. In 2004 Pat Dorsey, then Morningstar’s Director of Research wrote The Five Rules For Successful Stock Investing with a parallel two-part structure. I prefer the current book as it is more to the point - focused on moats - and the industry descriptions are less general and better ties in with the preceding discussion on competitive advantages. Also, there are a larger number of illuminating corporate case studies in Why Moats Matter. Where the target audience for the first book felt like the retail investor, even seasoned value investors can appreciate this one.

No objections? With regards to the book there is one chapter on applying moats to dividend investing that felt a bit out of place and redundant. To some extent I would have appreciated a more thorough discussion on how several moats can enforce each other. Columbia’s Bruce Greenwald has pointed to the combination of scale economies and some source of customer captivity as the most enduring competitive advantage. Concerning the methodology I would argue that Morningstar’s practice of emphasizing duration over size when judging moats is a bit narrow. The size of the excess return and the ability to invest plenty of capital without diminishing the return also matters.

However, we are talking fine print here. I definitely think the book delivers on its (stated) aim.

This is a review by investingbythebooks.com
8 of 11 people found the following review helpful
5.0 out of 5 stars Great book, well worth the time if you have any interest in analyzing competitive advantages 29 July 2014
By Marc - Published on Amazon.com
Format:Kindle Edition|Verified Purchase
Great book, it really expanded on Pat Dorsey's book by adding checklists and key questions to ask to identify competitive advantages. The industry sections at the back are a great primer for key aspects of business models.
6 of 9 people found the following review helpful
2.0 out of 5 stars Miss Brilliant Fun 28 Aug 2014
By Jackal - Published on Amazon.com
Format:Hardcover|Verified Purchase
We are seeing more and more investment books deal with competitive advantage as opposed to just the financial statements. This book gives an overview of Morningstar's approach. The authors describe five sources of competitive advantage. In their terminology "moats" (homage to or free-ride on Warren Buffett). The methodology comes across as quite primitive, if you have knowledge of strategic management. Still I applaud the direction towards assessment of competitive advantage. If you are interested in this approach my recommendation is Competition Demystified: A Radically Simplified Approach to Business Strategy.

In the chapter evaluating the methodology, they find no difference between moat stocks and non-moat stocks after one month!!!! However, moat stock have less variability in returns. The authors provide no information on longer time horizons than a month. My suspicion is that their methodology does not work. The chapter on evaluation is awful, because the methodology is so primitive. The moat strategy has probably been designed using past performance data. It is then not acceptable to use the same historical time period for evaluating the the strategy. I will not say more. No data provided on individual moats.

I am not surprised that there is no relationship between moats and returns. The methodology is simply too primitive. Check out the reference provided above for a deeper understanding. The authors should have thought about moat interactions, additional moats, and even competitors. I thought that the book would contain a dumbed-down version of the Morningstar methodology. True, to a large extent the book is marketing. For instance it does not contain single reference to other works. However, given the weak performance evaluation, I am not sure the key objective is marketing. Maybe the book is just an honest attempt to showcase the methodology. In that case why not think a bit more before publishing?

The second half of the book provides some industry discussions. I really wish the authors would have taken some specific, old examples and discussed the approach in detail. I want to see feathery brilliant thinking, but instead I get a very mundanely written chapters. Where is the excitement dear authors? What you are trying to do is fun stuff. Let it show. In fact, show us your brilliance by putting some current examples in the book. Then you have "skin in the game".

I could give it 2 or 3 stars. I will settle for 2 because they authors have so much resources available in their big firm. And they did not manage to accomplish a lot (but the direction is good). It should appeal mainly to non-professionals. If you have time and interest read Competition Demystified: A Radically Simplified Approach to Business Strategy instead.
5.0 out of 5 stars An intelligent investors guidebook 8 Sep 2014
By MFSI - Published on Amazon.com
Format:Kindle Edition|Verified Purchase
This book delves into the details of why good companies make good long term investments. It gives the intelligent investor the tools needed to make sounds investments decisions, not just the hot pick of the day
5.0 out of 5 stars Five Stars 15 Sep 2014
By Kenneth Morris - Published on Amazon.com
Format:Hardcover|Verified Purchase
Great book and the proper way to think about investing.
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