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By Matthew Coffina, CFA and Elizabeth Collins, CFA | 05-21-2013 11:00 AM

5 Names From Our 5 Sources of Moats

Morningstar's Matt Coffina and Elizabeth Collins discuss how our moat committee distinguishes companies with moats, and they offer examples of stocks that carry these competitive advantages.

Matt Coffina: For Morningstar, I’m Matt Coffina. I’m joined today by Elizabeth Collins, who is the director of our basic materials team and also chairs our economic moat committee. We’re going to talk about how the moat committee works and how Morningstar assigns economic moat ratings to companies.

Thanks for joining me, Elizabeth.

Elizabeth Collins: Thanks for having me.

Coffina: First, could you tell us how does the moat committee work, and why is it important to our equity-research process?

Collins: On the moat committee, we have a little bit over 15 senior members of the equity research department. And this moat committee meets about two to three times a week, and we vote on analyst proposals for their company’s moat ratings. And basically, the analysts make a case for why they think a company should have a particular moat rating. We ask critical-thinking questions about the company’s competitive advantages. Then the voters cast their votes, and the majority rules.

I think it’s important for our equity research methodology because it ensures consistency and rigor, and so that if you’re reading about a moat rating on any particular company, you know that it’s consistently applied across our coverage universe. It's comparable on an apples-to-apples basis no matter what the sector or industry is.

Coffina: Morningstar has identified five sources of an economic moat. Can you tell me what those are?

Collins: Sure. We’ve intangible assets, customer switching costs, cost advantages, network effect, and the efficient scale phenomenon.

Coffina: Start with cost advantages. What is that and what’s an example of a company with a cost advantage?

Collins: Sure. So, a cost advantage, it might be that you’re selling a commodity product or something where there is not an opportunity to differentiate on prices. But if you’re a company [with a cost advantage] you have an advantage because of your ability to sustainably produce the good or service at a cost lower than everybody else. So, you capture that spread between prices that everybody is charging and your costs, which are lower than everybody else’s.

And a good example on this category would be Ultra Petroleum, which is a natural gas producer. Mother Nature gave them very advantaged geological assets that they had for many years, and they produce natural gas at a cost lower than the rest of their peers.

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