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Why Moats Matter: The Morningstar Approach to Stock Investing Hardcover – 22 Aug 2014
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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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Drawing on one of Warren Buffett’s favorite analogies – “The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” – Brilliant and Collins thoroughly explore the concept of economic moats: what gives rise to them, how likely are they expected to persist, and, with the help of colleague Todd Wenning, how managerial stewardship as evaluated through the lens of capital allocation decisions either fills or defends the competitive moat.
Moat sources as identified by the authors and echoed elsewhere (cf. William Bernstein’s Rational Expectations and Mauldin & Tepper’s Code Red) include:
• Intangibles – patents, R&D, brands, regulatory protection, and, well, intangibles
• Cost Advantage
• Switching Costs – for example, entrenched software platforms
• Network Effect – every seller on eBay means more value to potential buyers and vice versa
• Efficient Scale
The second part of the book focuses on valuation. It does no good to overpay for a competitive moat. The authors illustrate Morningstar’s rating methodology tying in the moat analysis and ending with a star rating that encompasses valuation relative to market price as well as the uncertainty surrounding that valuation (it should come as no surprise that this reflects the Graham/Buffett dictum of ‘margin of safety’).
Finally, the section that makes this book a must-read for any serious stock-picker: a sector-by-sector, industry-by-industry case-study analysis of moats by sources complete with the distribution of the presence (and width) of moats within the sector. Part ‘why-you-shouldn’t-try’ and part ‘how-to’, the authors do a great job of showing how much work and detail goes into this sort of analysis; enough to scare off the dilettante one hopes, but simultaneously assuring the serious professional that the analysts know what they are about.
Qualitative security analysis often takes a back seat to the ‘quants’, but this work creates a practical appreciation of the art of security analysis.