Seven Questions about Our Moat Ratings -- Page 2

Do Moats Correlate with Stewardship Grades?
We also evaluate the stewardship of a company independent from its moat, yet the two ratings are clearly correlated. We've repeatedly found that there is no limit to the value- and moat-destroying capabilities of some management teams. Although we don't think a superior management team alone can be moat-worthy, an incompetent team can certainly destroy a moat all by itself. One need look no further than the banking industry to find the greatest value-destroying management teams in 2008, but  Ticketmaster's  management has found a creative way to destroy value in 2009. The company recently announced a proposal to merge with Live Nation. Ticketmaster alone is a powerhouse in the highly profitable ticketing industry, but Live Nation can barely generate positive free cash flow in the highly competitive concert promotion industry. This proposed merger of equals will destroy value for Ticketmaster shareholders in our opinion.

Correlation between Moats and Stewardship Grades
Stewardship	Wide	Narrow	None
A	32%	53%	15%
B	9%	45%	47%
C	7%	34%	58%
D	5%	23%	73%
F	0%	27%	73%
Data through 2-16-09.

Do Moats Correlate with Financial Health Grades?
Our recently improved financial health grade is generated via an algorithm designed to determine how close a company may be to defaulting on its debt. While debt alone is moat-neutral, too much debt can be a huge burden in a competitive market. For example,  Orbitz  is in such poor financial health that it must use most of the cash it earns to pay interest and principal payments while its competitors,  Expedia (EXPE) and  Priceline (PCLN), are reinvesting in their businesses and pursuing international expansion. Orbitz will be at a significant disadvantage as the other two companies entrench themselves in new markets. From another perspective, creditors are suppliers of capital, and they can be analyzed as such in the context of Michael Porter's five forces. Very few companies have much power over creditors, leaving highly leveraged debtors in a precarious situation when fear creeps into credit markets. Several banks learned this lesson the hard way in 2008. As a result of the fundamental links between competition and debt, you can see a mild correlation between our moat ratings and our financial health grades.

Correlation between Moats and Financial Health Grades
Financial Health	Wide	Narrow	None
A	25%	26%	48%
B	10%	44%	46%
C	3%	60%	36%
D	2%	76%	22%
F	0%	90%	10%
Data through 2-16-09.

How Frequently Do Moat Ratings Change?
As a result of our deliberative analysis of competitive advantages, we tend to have very high conviction in our moat ratings, which accordingly experience relatively low turnover. Still, moat ratings are often the subject of rigorous internal debate and we are not afraid to change our minds in the face of concrete evidence. Consequently we've had a 6% average turnover rate over the past five years. Moat turnover has increased recently due to the re-evaluation of several moat ratings based on evidence that has surfaced during the current economic crisis. Most notably, we have downgraded several moat ratings in the financial services industry.

Which Wide-Moat Firms Are Most Attractive Today?
While wide-moat companies are currently more attractive than ever, there have always been wide-moat gems in our coverage universe. The table below lists the 10 cheapest wide-moat stocks, excluding stocks with very high and extreme uncertainty ratings, Stewardship Grades below C, or financial health grades below C. A complete list of our wide-moat stocks can be found  here.

10 Cheapest Wide-Moat Companies
Company	Price/ Fair Value	Sector	Fair Value Uncertainty	Stewardship Grade	Financial Health
American Express (AXP)	0.29	Fin. Svcs	High	A	C
US Bancorp (USB)	0.35	Fin. Svcs	High	A	C
General Electric (GE)	0.41	Ind. Mtls	Medium	B	C
International Speedway	0.41	Cons. Goods	Medium	C	A
Applied Materials (AMAT)	0.43	Hardware	Medium	C	B
KLA-Tencor (KLAC)	0.44	Hardware	Medium	C	B
Harley-Davidson (HOG)	0.44	Cons.Goods	High	B	C
The Western Union Co. (WU)	0.45	Fin. Svcs	Medium	C	B
Enterprise GP Holdings L.P.	0.45	Energy	Medium	B	C
Legg Mason	0.46	Fin. Svcs	High	C	C
Data through 2-16-09.

We will be writing a series of articles delving into the performance of our equity research ratings and simulated strategies based on those ratings. If you have an idea that you'd like us to write about, please contact us using the "analyst feedback" link at the bottom of this article. We look forward to hearing from you.

* Data from Morningstar as of Feb. 16, 2009.

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