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Why Moats Matter: The Morningstar Approach to Stock Investing Hardcover – July 21, 2014
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From the Inside Flap
Just as physical moats protect castles from enemies, economicmoatsor sustainable competitive advantagesprotectcompanies from competitors. Legendary investor Warren Buffettdevised the economic moat concept. Morningstar has made it thefoundation of a successful stock-investing philosophy.
At Morningstar, we've always viewed investing in the mostfundamental sense: We want to hold shares in great businesses forlong periods of time. How can you tell a great business from a poorone? A great business can fend off competition and earn highreturns on capital for many years to come. The key to finding thesegreat companies is identifying economic moats that stem from atleast one of five sources of competitive advantagecostadvantage, intangible assets, switching costs, efficient scale, andnetwork effecteach of which we explore in great depth.
Even better than finding a great business is finding one at agreat price. The stock market affords virtually unlimitedopportunities to track prices and buy or sell securities at anyhour of the day or night. But looking past that noise andunderstanding the value of a business' underlying cash flows is thekey to successful long-term investing. When you focus on acompany's fundamental value relative to its stock price, and notwhere the stock price sits today versus a month ago, a day ago, orfive 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 getrich quick by juggling stocks. What it will give you is afundamental framework for successful long-term investing. The bookwill help you answer two key questions: How can I identify a greatbusiness, and when should I buy that business to maximize myreturn? 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, butit's one that has worked well over the years. Using fundamentalmoat and valuation analysis has led to superior risk-adjustedreturns and made Morningstar analysts some of the industry's topstock-pickers. In this book, we share all the ins and outs of ourmoat-driven investment philosophy, which you can use to identifygreat stock picks for your own portfolio.
To find out more about Morningstar's approach to stock investingand 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 ofvalue investing. These modern-day protected business castles allowtheir owners to earn high returns on capital, the ultimate goal forany long-term investor. In Why Moats Matter, HeatherBrilliant and Elizabeth Collins provide a wonderfully detailed mapto help both small and large investors find these greatcompanies."
—John W. Rogers Jr., founder, chairman, and chiefinvestment officer, Ariel Investments
"Morningstar's Economic Moat framework is a useful complement toMichael Porter's five forces model, as it approaches the issue offranchise quality from an investor's perspective. Armed withMorningstar's moat framework, I've been able to make betterassessments of companies' competitive positions, which is acritical element of my stock-picking process."
—Michael Luciano, investment analyst and U.K. pilotfund 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.