We identify the companies which have created economic moats using the criteria of Morningstar
23-May-2023 •Vishal Goyal
Ancient castles had deep, wide ditches filled with water around them called a moat, which protected them from attacks. Similarly, successful companies build 'economic moats', in simpler words - competitive advantage. These moats can be either qualitative or quantitative, and they protect companies from their competitors. Some common ones are proprietary technology, patents, intangible assets, cost advantages, efficient scale, customer switching costs, network effects, etc.
The telltale signs of moat
Who wouldn't want to invest in companies that have an advantage over their peers? Hence, investors are always on the lookout for companies with a moat.
So the next question is how to identify companies with moats.
Experts like Pat Dorsey of Morningstar believe moats are often evident in a company's long-term financials.
In his book, 'The Five Rules For Successful Stock Investing', he lays down specific criteria to identify companies with moats.
Quantitative identifiers
Pat Dorsey mentions that one should look for both qualitative and quantitative factors to identify businesses with wide economic moats.
He suggests that if a company has created a strong enough moat, it will satisfy certain quantitative criteria for at least five years. And if it meets these financial criteria for 10 years, the moat is particularly strong.
The criteria given by Dorsey are as follows:
Hence, we decided to look for BSE companies that satisfied the above in each of the last 10 years. Here's what we found.
Qualitative identifiers
While quantitative screening is a good starting point, qualitative factors should also be considered while searching for companies with moats.
To this end, Dorsey has also written about different kinds of qualitative moats, factors that can't be quantised but help companies grow.
In short, there are both qualitative and quantitative aspects to moats. But, as Dorsey says, these benchmarks are just the rules of thumb, not strict cut-offs. Therefore, do the due diligence before investing. Moats are just one of the multitude of factors that should be considered before investing in a business.
Suggested read: Six parameters to look for in a company before investing
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