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Stock Strategist

How to Recognize Wide-Moat Firms

Strong historical profitability is only part of the story.

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What gives a company a wide economic moat? I get this question all the time, and it bears some discussion, since analyzing moats and thinking about competitive advantage is at the core of what we do at Morningstar.

People often think that analyzing moats is as simple as looking for strong historical profitability. Ah, if only it were that easy. In truth, history is an imperfect guide, since the value a company will create for shareholders is dependent on how well it fends off competition in the future. High returns on capital attract competitors, and those great historical numbers will fade fast if a firm doesn't have a strong competitive advantage. Oftentimes, that competitive advantage isn't obvious--you have to do some digging into the firm's business model to figure it out.

Pat Dorsey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.