Five Wide-Moat Stock Winners

As the editor of Morningstar StockInvestor, I'm always looking for stocks to add to StockInvestor's Tortoise and Hare portfolios. I'm not just looking for stocks that trade at big discounts to our fair value estimates, however; I'm also looking for great businesses.

Why?

Great businesses typically withstand the inevitable economic, competitive, and other challenges that often cripple weaker businesses. So focusing on great businesses provides me with a margin of safety that I wouldn't get by investing in poor businesses. Focusing on great businesses also allows me to hold on to my stocks longer than would otherwise be the case. This reduces the transaction costs and taxes that come with heavy trading, and that can be very damaging to long-term investment performance. This is one reason that both the Tortoise and Hare portfolios have beaten the market so soundly since their inception.

A quick way to gauge Morningstar's opinion of a particular business is to look at the company's economic moat rating. We've borrowed the moat imagery from Warren Buffett, who likes to invest in businesses with "economic castles protected by unbreachable 'moats.'" Each company we cover is assigned a moat rating that varies from "none" to "wide."

Companies that receive a "none" moat rating have very few--if any--competitive advantages. This means that they can't keep competition from eating away at their profits. Lots of these companies don't even have any profits.  Delta Air Lines (DAL),  Albertson's , and  Goodyear Tire & Rubber (GT) are three examples of companies that we don't think have moats around their respective businesses. These are companies that I wouldn't want to hold on to for the long run, and so I wouldn't bother buying them in the first place.

A company gets a narrow-moat rating if our analyst can point to one or two advantages that the company possesses that should allow it to earn above its cost of capital for several years. More than half of the companies we cover earn a narrow-moat rating. Narrow-moat companies are on average of a much higher quality than no-moat companies. There are lots of narrow-moat firms that I'd be willing to hold on to for several years, and so I'll consider adding these stocks to the Tortoise or Hare, assuming that the price is attractive.  Washington Mutual (WM),  White Mountains Insurance (WTM) and  Fair Isaac (FIC) are three narrow-moat companies that we own in the Tortoise and Hare portfolios. We've owned WaMu and White Mountains since December 2001.

All things being equal, I'd choose a wide-moat company over one with a narrow-moat rating, and so I focus most of my time and attention on Morningstar's 150 wide-moat stocks. These are companies with significant competitive advantages that should enable them to earn more than the cost of capital for many years to come. The network effect, intangible assets, low-cost producer status, and high switching costs are the four competitive advantages we look for and find in these 150 companies. These are companies like  Berkshire Hathaway (BRK.B),  Home Depot (HD), and  Dell , any of which you could buy and hold on to for a very long time (and sleep well at night, to boot). We've held these stocks in either the Tortoise or Hare since September 2001. Of the 35 stocks that we currently own in the Tortoise and Hare portfolios, 29 have wide economic moats.

When I'm looking for stocks, I like to use Morningstar's  Premium Stock Screener. My favorite screen that I use all the time: wide-moat stocks that are currently trading at a 5-star price. (To run this screen for yourself,  click here.) Unfortunately, cash constraints won't allow me to buy all the gems I discover with this screen for the Tortoise or Hare. That doesn't mean that you shouldn't take a long look at several of the high-quality, attractively priced stocks that turned up on my most recent search. Below are five that I found very interesting; there are several others, as well.

Five Wide-Moat Stocks Worth a Look
Stock	Price	Fair Value Estimate	Star Rating	Moat	Risk
Anheuser-Busch (BUD)	$49.11	$64		Wide	Below Avg.
Cadbury Schweppes (CSG)	$36.70	$47		Wide	Below Avg.
Coca-Cola (KO)	$40.74	$54		Wide	Below Avg.
Colgate-Palmolive (CL)	$49.90	$60		Wide	Below Avg.
Fifth Third Bancorp (FITB)	$44.52	$56		Wide	Below Avg.
Data through Jan. 13, 2005

As you see, all of these stocks carry below-average risk, have wide moats, and are selling at steep discounts to fair value. Four of the five are consumer-products companies, which tend to be good defensive investments during choppy markets. These companies also make sense from a currency perspective.  Anheuser-Busch (BUD),  Coca-Cola (KO), and  Colgate-Palmolive (CL)have substantial international operations; a continued decline in the dollar would boost future results. Finally,  Fifth Third Bancorp  (FITB) is simply a great bank with good long-term prospects, and it hasn't been this cheap in a long, long time. If you're looking for a relatively safe financial stock that throws off a modest dividend, Fifth Third could be the answer.