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High-Quality Firms Getting Left in the Dust

Buying opportunities abound among high-quality, wide-moat businesses.

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From the doldrums of March, the stock market has made a remarkable recovery as investors regained confidence in the economy. The S&P is up over 45% since its bottom on March 9. But this rising tide has not lifted all boats equally. Previously, we wrote an article describing how the Financial, Hardware, and Industrial Materials sectors have been outpacing Utilities, Health Care, and Consumer Goods in the recent rally.

But there has also been a considerable spread between lower-quality firms and high-quality companies with competitive advantages. Our team of equity analysts assign an economic moat rating to every company they cover. Businesses that we think will be able to fend off the competition for years and consistently earn returns on invested capital above their cost of capital earn wide moats. Those that can't fend off competitors are rated no-moat. Narrow moat companies fall somewhere in the middle.

Since the S&P's bottom and the end of July, firms with wide moats have seen a 4.81% total return, narrow moat firms are up 16.6%, while no moat companies are up 26.1%. So has this outperformance been justified? We think not. No-moat companies were not trading at significantly lower discounts to our fair value estimates versus wide- or narrow-moat firms at the market bottom. We thought our entire stock coverage universe was about 40% undervalued before the rally.

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