Why Are Some of the Strongest Stocks Struggling This Year?

Investing Insights

In this episode of Investing Insights, host Ivana Hampton and Morningstar Magazine Editor-in-Chief Jerry Kerns discuss the concept of economic moats

Key takeaways

• Economic moats are categorized into five sources: network effect, intangible assets, cost advantage, switching costs, and efficient scale.
• The Morningstar Wide Moat Focus Index underperformed recently because its valuation component created a contrarian position in a winner-take-all market.

Main topics

• Economic Moats
• Market Volatility

Notable quotes

An economic moat represents a company's durable competitive advantage.

Conclusion

The episode reinforces that while market cycles cause temporary diverg

Transcript preview

Speaker 2 (0:00) Please stay tuned for important disclosure information at the conclusion of this episode. Speaker 1 (0:11) Welcome to Investing Insights. I'm your host, Ivana Hampton. Are why most stocks struggles, a sign of their protection diminishing? That's the big question from the Q3 issue of Morningstar Magazine. Key market moments this year heavily weighed on some stocks with competitive advantages. So why did they stumble? Morningstar Magazine editor-in-chief, Jerry Kearns, is returning to Investing Insights to discuss this issue's cover story. Speaker 1 (0:38) Welcome back, Jerry. Speaker 3 (0:40) Thank you. It's great to be back. Speaker 1 (0:41) So let's start with an explainer. What is a moat and can you describe the five sources of moat? Speaker 3 (0:48) Yes. So a economic moat represents a company's durable competitive advantage. It's what allows a company to earn excess returns over a long period of time. And Morningstar's analysts, our equity analysts, assign a moat to every company they cover. And this could be a wide moat, a narrow moat, or a none moat. We expect wide moat companies to fend off their competition for 20 years. Narrow moat companies fend off their competition for at least 10 years. And obviously, none means no moat. Speaker 3 (1:24) So yes, about the sources of where do companies get these competitive advantages? And there are five. The first is a network effect, which is the more people use a service, the more valuable that service becomes for its users. Visa, MasterCard, Amazon.com, Alphabet are good examples of those companies. Then you have intangible assets, which are like patents, brands, regulatory licenses that companies own that gives them a competitive advantage. Apple, Coca-Cola are two examples of companies with intangible assets. The third is cost advantage, companies that can undercut their competitors for various reasons, like Walmart, Costco, Grainger, all have cheap prices, and they can be competitive with those prices. And we have switching costs, which is when it's too expensive or troublesome for users to... change products and move to a competitor. They are kind of stuck with your product. JP Morgan Chase is an example, Microsoft, Salesforce. These are all companies that kind of have their customers. Efficient scale is the fifth and final one. And this is when a niche market is served by one company or maybe a handful of companies. It's not a big market, but they dominate the market. Union Pacific, Dominion Energy. American Tower are all examples of that. So those are the five sources. Speaker 1 (2:54) I love that you included examples with each moat source. Speaker 3 (2:58) Yeah, well, I mean, it's kind of an interesting thing, too, is companies can have more than one moat source. So the