Morningstar Is Retiring the Moat Trend Rating

Morningstar Equity Research has decided to retire the Morningstar Moat Trend Rating data point on July 27, 2023.

The Moat Trend retirement will not affect any of our Morningstar Economic Moat Ratings or research. Also, the Moat Trend is not a direct input to our valuation methodology and therefore will not result in any fair value estimate or star rating changes.

With the Moat Trend Rating, we aimed to identify companies with a strengthening or weakening competitive position, identified with a rating of Positive or Negative, respectively. Companies whose position we believed to be neither strengthening nor weakening were assigned a rating of Stable.

While compelling in theory, there have been several issues in practice, and the rating’s performance has not consistently met our high expectations:

• Too few companies have been assigned a Positive or Negative rating. Competitive dynamics tend to be fluid, so we should expect a meaningful share of Positive and Negative ratings. However, at present, only 6% of companies are assigned a Positive Moat Trend and only 12% a Negative Moat Trend. This suggests our rating may inadequately capture the dynamism that defines most industries.
• Positive and Negative ratings have been overly concentrated in a handful of industries. Over half of Negative ratings are clustered in three sectors. Positive ratings are even more concentrated. Over 80% of Positive ratings are found in the consumer cyclical, healthcare, and technology sectors. This is concerning because it suggests we may be conflating secular growth with an improving competitive position.
• Positive and Negative ratings are detected more easily in a few moat sources. With the Moat Trend rating, we aim to isolate which moat source is strengthening or weakening: intangible assets, switching costs, cost advantage, network effect, or efficient scale. But it seems we’ve done a better job detecting changes in some moat sources than others. For example, companies with a switching cost moat source are far more likely to be assigned a Positive trend. By contrast, those with an efficient scale moat source are more likely to be rated Negative trend. There’s little economic logic to suggest either should be the case.
• Moat Trend hasn’t been a strong predictor of future moat rating changes. The rating is intended to identify cases in which a moat may be widening or narrowing. However, Positive and Negative trend ratings have not consistently led to an eventual moat rating upgrade or downgrade.
• The rating hasn’t been a strong predictor of future share price performance. Unlike the moat rating, which is a key input to our valuation methodology, the Moat Trend rating does not directly inform our fair value estimates. While it was never intended as a valuation signal, we recognize that some investors have opted to use the rating for this purpose. We’ve found little evidence to suggest efficacy on this front.

Our decision to retire the Moat Trend rating is predicated on our mission: to empower investor success. Because the rating did not consistently meet our expectations, we have decided to redirect our efforts elsewhere. For example, we will be expanding our coverage by over 100 stocks in 2023, allowing investors to deploy our ratings and research against an even broader and more global opportunity set: over 1,600 stocks by year-end.