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How Wide Is Your Company's Moat?
Do you believe in the investing principles of Ben Graham? I do. As such, I often find myself writing about the margin of safety, an idea Graham developed many decades ago that is still discussed today. Often referred to as an economic moat, it is a company's ability to protect its competitive advantage over many years. The bigger your company's moat, the better an investment it is or so the theory goes.
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The Proof is in the Pudding
Morningstar has an index it terms the "Morningstar Wide Moat Focus," a collection of 20 stocks that it deems the cheapest in terms of price-to-fair-value while still possessing a wide moat. To obtain this select group of companies, Morningstar performs a stock screen that reduces a list of 2000 down to 174, ultimately resulting in the final group.
Over the past five years, this index has managed to produce annualized returns of 4.81% and year-to-date is up 11.30%. Over five years on an annualized basis, it's outperformed the S&P 500 by 7.43% and 12.57% year-to-date. Every three months Morningstar redoes the list determining the newest and cheapest 20 stocks with a wide moat. The results speak for themselves.
A Slight Variation
To narrow the list even further, I'm going to take the current 20 stocks and add my own two criteria to the screening mix. I'm hoping that the resulting five stocks will outperform Morningstar's index over the coming quarters. In order to make this list, both the price-to-sales and PEG ratios had to be positive. The winning five are the lowest results of all 20. Keep in mind stock screens aren't always 100% reliable and while not very scientific, the combination of these two ratios allows us to find a little growth on top of value. GARP investors should be interested.
Top Five Stocks With A Wide Moat
A Diverse Group
Even though this is a portfolio of just five stocks, it's still fairly diverse, with three sectors represented including services, financial and consumer goods. The three service sector stocks include Lowe's, IMS Health and Time Warner Cable and all of them should grow once the economy recovers.
If there were a glaring weakness here, analysts would suggest it is the inclusion of Harley Davidson, a company appearing long past its prime. UBS Investment Research analyst Robin Farley suggested in June that Harley Davidson's sales "hit a wall" in April and May, dropping 35% in each period, making it abundantly clear that new CEO Keith Wandell has his work cut out for him.
On July 13, RBC Capital Markets lowered its sales numbers for Harley, recommending investors stay away from the Wisconsin motorcycle manufacturer until further notice. Personally, I believe Harley is the sleeper pick of the five and Berkshire Hathaway's (NYSE:BRK.A) February purchase of $300 million in senior unsecured notes paying 15% and maturing in 2014 is an indication Buffett sees better times ahead.
The Bottom Line
Investors looking at wide moat stocks need to forget the here and now and look ahead five or ten years. All five companies listed above are operating businesses with high barriers to entry. To start a motorcycle company today takes a lot of cash, just ask Polaris Industries (NYSE:PII). Makers of Victory bikes, it's taken them 12 hard years to make permanent inroads into the motorcycle business. You can't do that without serious financial support. The key here is to understand why these companies have economic moats and then determine how realistic it is for others to take that away. In many cases, it might just be impossible. (For more, read Stock-Picking Strategies: GARP Investing.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
IN PICTURES: World's Greatest Investors
The Proof is in the Pudding
Morningstar has an index it terms the "Morningstar Wide Moat Focus," a collection of 20 stocks that it deems the cheapest in terms of price-to-fair-value while still possessing a wide moat. To obtain this select group of companies, Morningstar performs a stock screen that reduces a list of 2000 down to 174, ultimately resulting in the final group.
Over the past five years, this index has managed to produce annualized returns of 4.81% and year-to-date is up 11.30%. Over five years on an annualized basis, it's outperformed the S&P 500 by 7.43% and 12.57% year-to-date. Every three months Morningstar redoes the list determining the newest and cheapest 20 stocks with a wide moat. The results speak for themselves.
A Slight Variation
To narrow the list even further, I'm going to take the current 20 stocks and add my own two criteria to the screening mix. I'm hoping that the resulting five stocks will outperform Morningstar's index over the coming quarters. In order to make this list, both the price-to-sales and PEG ratios had to be positive. The winning five are the lowest results of all 20. Keep in mind stock screens aren't always 100% reliable and while not very scientific, the combination of these two ratios allows us to find a little growth on top of value. GARP investors should be interested.
Top Five Stocks With A Wide Moat
|
Company |
P/S |
PEG |
P/S*PEG |
|
Lowe\'s (NYSE:LOW) |
0.58 |
1.25 |
0.72 |
|
IMS Health (NYSE:RX) |
0.96 |
0.83 |
0.80 |
|
Time Warner Cable (NYSE:TWC) |
0.59 |
1.41 |
0.83 |
|
Harley Davidson (NYSE:HOG) |
0.64 |
1.34 |
0.85 |
|
RenaissanceRe Holdings (NYSE:RNR) |
2.42 |
0.77 |
1.86 |
A Diverse Group
Even though this is a portfolio of just five stocks, it's still fairly diverse, with three sectors represented including services, financial and consumer goods. The three service sector stocks include Lowe's, IMS Health and Time Warner Cable and all of them should grow once the economy recovers.
If there were a glaring weakness here, analysts would suggest it is the inclusion of Harley Davidson, a company appearing long past its prime. UBS Investment Research analyst Robin Farley suggested in June that Harley Davidson's sales "hit a wall" in April and May, dropping 35% in each period, making it abundantly clear that new CEO Keith Wandell has his work cut out for him.
On July 13, RBC Capital Markets lowered its sales numbers for Harley, recommending investors stay away from the Wisconsin motorcycle manufacturer until further notice. Personally, I believe Harley is the sleeper pick of the five and Berkshire Hathaway's (NYSE:BRK.A) February purchase of $300 million in senior unsecured notes paying 15% and maturing in 2014 is an indication Buffett sees better times ahead.
The Bottom Line
Investors looking at wide moat stocks need to forget the here and now and look ahead five or ten years. All five companies listed above are operating businesses with high barriers to entry. To start a motorcycle company today takes a lot of cash, just ask Polaris Industries (NYSE:PII). Makers of Victory bikes, it's taken them 12 hard years to make permanent inroads into the motorcycle business. You can't do that without serious financial support. The key here is to understand why these companies have economic moats and then determine how realistic it is for others to take that away. In many cases, it might just be impossible. (For more, read Stock-Picking Strategies: GARP Investing.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Will Ashworth
Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.
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