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Stock Strategist

Dig a Moat for Your Investments

Ruminations on enhancing and sustaining returns.

Economic moats--forces that sustain monopolistic profits--are a virtue Morningstar assiduously seeks among the more than 1,500 stocks we research. Companies boasting wide economic moats, such as  Fidelity National Financial (FNF) or  Moodys  (MCO), earn high returns on capital because they are difficult to compete with--a benefit that translates into outsized returns for investors over long periods. Conversely, companies that lack moats lead a hardscrabble existence confronting brutal competition and eking out unappealing returns.

We think the moat concept has broader applicability. In our view, investors who compete for returns in the financial markets can take concrete steps to widen their "investment moat"--which in this context refers to an ability to consistently outperform a market benchmark. By focusing on market segments in which they boast a competitive edge, developing private valuation insights and reducing temperament-driven errors that impede rational thinking, investors can meaningfully improve their returns. Although we view these as the three key ingredients for widening an investment moat, we caution that we are offering a framework rather than a prescriptive recipe. Investment moats take many shapes, and the most successful investors will be those who adapt the framework to amplify their unique strengths.