Paul Larson, Morningstar – Economic Moats: Sources & Outcomes

Paul Larson, Morningstar – Economic Moats: Sources & Outcomes

Paul Larson, Morningstar - Economic Moats: Sources & Outcomes


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Below are some notes from the Robert Miles Value Investing Conference which kicked off today.

Value Investor Conference: Omaha, Nebraska – May 3rd, 2012


Paul Larson, Morningstar, Inc. (NASDAQ:MORN) – Economic Moats: Sources & Outcomes

Mr. Larson is the Editor of Morningstar’s StockInvestor newsletter. He also manages StockInvestor’s Tortoise and Hare Portfolios.

  • Return On Invested Capital (ROIC) is the primary test of a business’ moat.
  • Moats general:
    • Capitalism works and competition reduces profitability… but some stay profitable
    • Moats are strategic business characteristics
      • Sustainable returns are more important than the ‘highest’ returns
      • Ex. Crocs (CROX) vs. Nokia (NOK) and Kinder Morgan (KMP) vs. Union Pacific (UPC)
      • 5 Sources of Moats (Morningstar)
        • Network Effects
          • The value of the service grows with additional users (circularity builds)
          • Ex. Mastercard (MC), Visa (V), E-Bay (EBAY), and Facebook (FB)
  • Cost Advantages
    • Economy of scale in distribution/manufacturing;  Low cost resource base
    • Ex. Compass Minerals (CMP), Ultra Petroleum (UPL)
  • Intangible Assets
    • Brands & Pricing Power – Sallie Mae (SLE) vs. Hershey (HSY), and Sony (SNU) vs. Tiffany (TIF)
    • Patents – Pharma
    • License & Government approvals – Casinos
    • Corporate Culture – Helpful, but not the strongest by itself
  • Switching Costs
    • Time=Money, Money=Time – Consumer & Bank sectors especially
    • Ex. Oracle (ORCL), Autodesk (ADSK), Micros Systems (MCRS), Intuit (INTU)
    • My note: coming from the architecture & engineering field, I can attest to ADSK’s dominate position.
  • Efficiencies of Scale
    • Limited market size; A new entrant would drive profits below cost of capital for all participants – Airports, Racetracks, Pipelines, Defense, Lubrizol
    • More modest profitability
  • Morningstar Moat rating originated from Warren Buffett
    • 1999 Fortune article
    • Measure by ROIC vs. WACC
    • Wide (10%), Narrow (50%), None (40%)
    • More moats in Consumer, Defense, Healthcare, Financial Services
    • Morningstar is currently working on explicit listings of companies’ competitive advantages for use in reports:
      • Multiple, smaller competitive advantages is better than one larger one
      • Best competitive advantage is Intangible Assets
        • Ex. Healthcare patents, Consumer brands
  • Least stable competitive advantage is Network Effects
  • Efficiency of Scale resulted in best market return past few years – likely due to Utilities
  • Switching Costs & Network Effects both seen on the most positive outliers – Apple (AAPL)
  • Wide Moat Focus Index – Morningstar
    • Roughly 120 ‘Wide Moat’ out of S&P Index
    • 20 cheapest chosen
    • Equally weighted and re-balanced quarterly
    • Fun fact: Telecom has never been in it
  • Q&A
    • Wide Moat Focus Index turnover?
      • Around 150%, average 5-6/20 each quarter
  • Track record of actual management compared to back testing?
    • They back tested to 2002. They started actual managing in 2007.
  • Narrow Moat/Wide Moat differentiation?
  • Comes back to sustainability of competitive advantages; (+/- 10-15) years (narrow) and greater (wide)

Dustin Hunter, SunRift Capital Partners (

 (These notes are to the best of my recollection and trusty ink pen. Discrepancies are due to my error in understanding & transcribing.)

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