Morningstar Magazine - August/September 2017 - 35

EXHIBIT 4

the highest trailing and current P/E (by far),
exhibit the highest growth, and have the lowest
dividend yields. Intangible-assets firms
do not finish first or last on any metric. Costadvantage firms have the highest market caps and
are the least shorted. Efficient-scale firms trade
at the lowest current P/E, have the lowest
growth, are the most shorted, have the lowest
market caps, and offer the highest dividend yields.
Sources and Outcomes
We have identified the sources of competitive
advantage for every company with a narrow or
wide economic moat rating. Each of these
companies sources its moat from one or more of
these categories: intangible assets, cost
advantage, switching costs, network effect, or
efficient scale. In this article, we took our
qualitative assessments of competitive advantage
regarding these sources and tied them to
quantitative measures of performance for several
different large and diversified cohorts.

We found some striking differences in cohorts
defined by the source of competitive advantage.
For example, network effect is the most
likely to drive a wide moat rating, while efficient
scale most likely drives a narrow moat rating.
Network effect also drives better fundamental
performance than other moat sources
across nearly every metric examined. Meanwhile,
the combination of intangible assets and
cost advantage has delivered higher returns on
invested capital than any other moat-source
combination. This analysis shows that, although
it is a strong benefit for companies to hold
competitive advantages over peers, certain moat
sources lead to better financial performance
than others. K
Andrew Lane is a senior equity analyst with Morningstar
Research Services. He is chairman of Morningstar's
economic moat committee.
Danny Goode is an associate equity analyst with
Morningstar Research Services.

Polarizing Efficient-scale firms that also benefit from intangible assets delivered
very high five-year total returns. But efficient scale and cost advantage delivered
the lowest total returns.
Fundamental Performance by Combination of Moat Sources

Top Performer

Bottom Performer

Number of
Companies

Median
Annlzd 5 Yr
TR (%)

Mean
Annlzd 5 Yr
TR (%)

Median
Annlzd 10 Yr
TR (%)

Mean
Annlzd 10 Yr
TR (%)

Intangible Assets/Efficient Scale

19.1

17.9

10.6

10.5

Network Effect/Intangible Assets

18.8

20.7

10.5

12.5

Switching Cost/Network Effect

17.5

18.2

11.1

12.4

Network Effect/Cost Advantage

17.1

17.7

10.1

10.5

Switching Cost/Cost Advantage

16.5

16.3

7.3

6.9

Intangible Assets/Cost Advantage

167

16.4

17.1

9.8

10.3

Switching Cost/Intangible Assets

179

15.8

16.4

9.0

10.3

Switching Cost/Efficient Scale

14.3

14.8

11.5

10.8

Network Effect/Efficient Scale

14.0

14.8

7.8

6.9

Cost Advantage/Efficient Scale

12.2

7.0

7.3

Moat Sources

Source: Morningstar. Data as of 05/16/2017.

EXHIBIT 5

Big Effect Firms with network effects outperformed other moat sources.
Market Performance by Moat Rating and Moat Source

Top Performer

Bottom Performer

Number of
Companies

Median
Annlzd 5 Yr
TR (%)

Mean
Annlzd 5 Yr
TR (%)

Median
Annlzd 10 Yr
TR (%)

Mean
Annlzd 10 Yr
TR (%)

1,503

13.7

13.2

7.3

6.8

Wide-Moat Companies

209

15.7

15.6

10.6

11.0

Narrow-Moat Companies

643

15.5

16.0

8.6

9.0

No-Moat Companies

651

10.5

9.6

3.3

2.9

Switching Cost

314

16.4

16.5

9.3

8.9

Network Effect

112

17.1

18.0

10.0

11.7

Intangible Assets

491

15.9

15.7

8.9

Cost Advantage

358

15.9

15.7

8.9

Efficient Scale

200

13.2

13.3

9.0

8.5

Morningstar Coverage Universe
Moat Rating

Moat Source

All figures are medians
Source: Morningstar. Data as of 05/16/2017.

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