Economic Moat

The Morningstar Economic Moat Rating represents a company's durable competitive advantage. An economic moat (a term coined by Warren Buffett) is what allows a company to earn excess returns on capital for a long period of time and keep competitors at bay.

Morningstar analysts assign every company they cover a Morningstar Economic Moat Rating of wide, narrow, or none. A company whose competitive advantages we expect to last more than 20 years has a wide moat. One that can fend off its rivals for 10 years has a narrow moat. A firm with either no advantage or one that we think will quickly dissipate has no moat.

Morningstar has identified five sources that create economic moats:

Network effect A network effect occurs when the value of a company’s service increases for both new and existing users as more people use the service.

Intangible assets Patents, brands, regulatory licenses, and other intangible assets can prevent competitors from duplicating a company’s products or allow the company to charge higher prices.

Cost advantage Firms with a structural cost advantage can either undercut competitors on price while earning similar margins, or they can charge market-level prices while earning relatively high margins.

Switching costs When it would be too expensive or troublesome to stop using a company’s products, that indicates pricing power.

Efficient scale When a niche market is effectively served by one or only a handful of companies, efficient scale may be present.