Economic moats — a term Morningstar borrowed from Warren Buffett — are what keep a companies’ competitors at bay. An economic moat is a sustainable competitive advantage that allows a company to earn excess returns on capital for a long period of time. The moat may be established because of a cost advantage, patented products or efficiencies of scale. Companies without a moat are more vulnerable to losing market share, customers and eventually, profits.
A company’s moat is described as narrow or wide, depending on the strength of its competitive advantage. Those companies with a wide moat are less vulnerable to stock market fluctuations, and dominate their chosen sector. Shareholders of these companies can expect a stable share price and where dividends are paid, a steady source of income. Wide, stable moat companies tend to be defensive in nature – these stocks will not double overnight – but they can form the reliable core of a portfolio.
Using Morningstar Select we have identified five companies with a stable competitive advantage over their peers, and which are currently trading at or below their fair share price value.
British American Tobacco (BATS)
Powerful intangible assets are at the core of British American Tobacco's wide economic moat. In addition, the company's platform of total tobacco products and e-cigarettes gives the firm economies of scope and scale that make it difficult for new entrants to gain the critical mass of volume necessary to compete.
Diageo (DGE)
Diageo has built a wide economic moat thanks to its unmatched distribution scale, bevy of strong brands, and impressive distribution network in the U.S.--the most profitable spirits market in the world. These competitive advantages would be outrageously difficult for a new entrant to duplicate.
GlaxoSmithKline (GSK)
Glaxo holds a wide economic moat on the basis of patents, a powerful distribution network, economies of scale, and diverse operations. Similar to its peer group, Glaxo's branded drugs hold patent protection that keeps competitors at bay for several years, while the company can charge prices that enable returns on invested capital above its cost. The delay in competition also enables the company to develop the next generation of patent-protected drugs to evergreen its pricing strategy.
SABMiller (SAB)
SABMiller's wide economic moat stems from its vast global scale. With 242 million hectoliters of lager volume in fiscal 2013, SABMiller is the second-largest brewer in the world, behind AB InBev. SABMiller's size gives it economies of scale that allow the firm to generate above-industry-average returns on invested capital.
Unilever (ULVR)
Unilever has a wide moat due to the strength of its brand portfolio and its vast scale, which would be costly to replicate. Unilever is the third-largest packaged food firm in the world and one of the largest global household and personal product firms. The pricing power inherent in Unilever's brand portfolio is evident in the fact that it has been able to increase prices across its product assortment while still expanding volume over many years.
