Equity Moat Ratings: The Ultimate Guide for Asset Managers

How can asset managers build stronger funds and portfolios? The ability to identify companies and stocks with a long-term competitive advantage, or economic moat, may make a difference. That’s because an economic moat not only fends off competition but can also lead to high returns on capital for many years to come.

Our comprehensive guide shares actionable tips, resources, and tools to help you support clients and make more informed investing decisions.

Morningstar Equity Research defines a company with an economic moat as one with a structural competitive advantage that allows it to sustain economic profits—returns on invested capital above a firm’s weighted average cost of capital—over a long period of time. As a result, these companies are more likely to create value for themselves and their shareholders, which can lead to providing funds and portfolios that align with client needs.

While businesses with sustainable competitive advantages are rare, history shows that some companies have been able to withstand the onslaught of competition—often becoming wealth-compounding machines.

Morningstar has developed the economic moat concept into a comprehensive framework that can be applied consistently across a broad, global list of companies. The Morningstar Economic Moat Rating is a proprietary data point that refers to how likely a company is to keep competitors at bay for an extended period.

We look for five sources of structural competitive advantage when evaluating a company’s moat.

Unique features such as patents, brands, and regulatory licenses can prevent competitors from duplicating a company’s products or allow the company to charge higher prices.

Each of these helps increase pricing power—for example, patents protect the excess returns of many pharmaceutical manufacturers, such as Novartis (NVS). When patents expire, generic competition can quickly push drug prices down 80% or more.

If stopping using a company’s products is too expensive or troublesome, customers are less likely to make the switch. Consider a firm enrolled with an HR software provider like Workday (WDAY).

Every employee is trained on the software, and the firm’s processes are integrated in this system, indicating that a switch would be time-consuming and expensive. But price isn’t the only determinant of switching costs—factors such as risk, hassle, and psychology may also be considered.

This occurs when the value of a company’s service increases—for consumers, suppliers, and developers—as more people use the service.

The more consumers who use Visa (V) credit cards, for instance, the more attractive that payment network becomes for merchants, which makes it more attractive for consumers, and so on.

Firms that can provide goods or services at a lower cost have an advantage because they can undercut their rivals on price or sell at the same price as rivals but achieve a fatter profit margin.

As the largest restaurant brand in the world, McDonalds (MCD) can procure food and paper more cost effectively than its smaller peers, an edge that we don’t expect to ease over the next few decades.

This dynamic typically applies to firms that service a market of limited size, in which potential competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital.

Let’s take a railroad company like Union Pacific (UNP). New firms have little incentive to enter the railroad market because of the sizable upfront infrastructure costs. Plus, competing with Union Pacific would mean they run the risk of creating excess capacity with limited demand, giving Union Pacific the ability to maintain its size and position in the railroad industry.

Through fundamental research, Morningstar equity analysts determine if a company holds one or more competitive advantages and whether they will result in excess returns for an extended period of time. Specifically, a moat committee of about 20 experienced analysts spanning sectors and geographies considers the five qualitative factors outlined above and oversees investment moat ratings, assigning companies with a wide moat, narrow moat, or no moat.

If a company has a wide moat, it has a strong defense against rival companies that we expect to last 20 years or more. A company with a narrow moat should maintain a competitive edge for at least 10 years. And no-moat companies don’t have any enduring competitive advantages. It’s important to note that just because a company boasts a well-known brand or has been in business for a long time, doesn’t necessarily mean it has an economic moat.

For the best long-term results, Morningstar analysts believe that combining a moat with an undervalued stock has a long track record of outperformance. This can be seen with the Morningstar Wide Moat Focus Index, a collection of the most undervalued US companies with analyst-assessed competitive advantages expected to last more than 20 years into the future. Meanwhile, the Morningstar Wide Moat Composite Index tracks all the stocks in the US market with wide moats.

The Morningstar Wide Moat Composite Index shows that wide-moat stocks are up 28.92% while narrow-moat stocks are up 25.48% and no-moat stocks lag the broader US market with a 14.43% gain. Narrow-moat stocks have outperformed no-moat stocks by 11.05 percentage points in 2024 through November—the largest gap in a single calendar year across the 21-year track record of the moat indexes.

Cheap high-quality names from the Morningstar Wide Moat Focus Index can be good long-term growth stocks to consider. Here were the most undervalued wide-moat stocks in the index as of December 2024.

1. Estee Lauder (EL)

2. Huntington Ingalls Industries (HII)

3. Pfizer (PFE)

4. International Flavors & Fragrances (IFF)

5. Nike (NKE)

6. Campbell Company (CPB)

7. Brown-Forman (BF.B)

8. Zimmer Biomet (ZBH) 

9. NXP Semiconductors (NXPI) 

10. MarketAxess Holdings (MKTX)

Even the highest-quality company could turn out to be a value-destructive investment if it’s purchased at an excessive price. Morningstar subscribes to a long-term valuation-driven investment approach, which weighs a business’ intrinsic value relative to its market price. While price and value can become disconnected in the short term, they should converge over the long term.

Our economic moat analysis and fair value estimates are also inextricably linked. Economic profits for companies with wide moats should persist longer than those for narrow-moat firms, resulting in a higher valuation. In turn, economic profits for no-moat firms should prove less persistent, if they even exist in the first place.

At the heart of Morningstar’s valuation methodology is a detailed projection of a company’s future cash flows based on fundamental research by equity analysts. Morningstar believes that analyzing valuation through discounted cash flows is the best way to view cyclical companies, high-growth firms, or companies expected to generate negative earnings over the next few years.

A discounted cash flow, or DCF, model is an optimal tool to express our long-term assessments of a firm’s competitive advantage and its impact on cash flows well into the future.

The Morningstar DCF model is divided into three distinct stages:

• Explicit forecasts: In this stage lasting five or 10 years, analysts make full financial statement forecasts, including items such as revenue, profit margins, and tax rates. Based on these projections, we calculate earnings before interest, after taxes, or EBI, and net new investment to derive our annual free cash flow forecast.

• Value of the moat: The second stage reflects how long economic profits should persist before a company’s returns on new invested capital, or RONIC, fall to its cost of capital. During this period that can last up to 15 years, we forecast cash flows using four assumptions: an average growth rate for EBI over the period, a normalized investment rate, average RONIC, and the number of years until perpetuity, when new invested capital no longer delivers economic profits.

• Perpetuity: Once a company’s marginal return on invested capital hits its cost of capital, we calculate a continuing value, using a standard perpetuity formula. At this stage, we assume that any growth or decline or investment in the business neither creates nor destroys value and that any new investment provides a return in line with estimated weighted average cost of capital.

Economic moat ratings and fair value estimates represent the moat focus indexes’ key inputs.

Stocks with moats have also tended to see smaller price swings than no-moat stocks. Historically, wide-moat stocks have had lower volatility than narrow-moat stocks and the broader equity market while no-moat stocks have shown the highest volatility.

Switching costs are the primary economic moat source within the software industry. Once software becomes integrated with other applications and embedded in workflows, it becomes very challenging to replace it. Retention is also a key metric that can help identify and measure a software company’s moat, which is typically higher for enterprise customers compared with small businesses or mid-market clients.

• Adobe: Wide moat.
  With its creative dominance and expanding portfolio, Adobe has built a worldwide standard in the PDF format and offers a leading marketing platform.

• AspenTech: Wide moat.
  Holding a leading competitive position in the highly specialized petroleum and chemical refining industries, the company’s returns historically were among the best within our software coverage.

• Atlassian: Narrow moat.
  The company has been undergoing a model transition that involves moving perpetual license sales to SaaS and subscription arrangements—given that perpetual license sales ended in February 2024, we expect both margins and returns to be at or near a bottom and should improve steadily in the coming years.

• Equinix: Narrow moat.
  As the largest third-party data center provider globally, the firm's highly connected ecosystem of data centers is a common meeting place for different parties, including enterprises and cloud vendors.

• SAP: Wide moat.
  Considered the global market leader in enterprise resource planning software, SAP’s current management has done primarily bolt-on acquisitions and focused on an organic turnaround of the firm through cloud product development and restructuring—which is now bearing fruit.

• Spotify: Narrow moat.
  Considering the company’s stature in the streaming music industry, we believe competitors will struggle to eat into Spotify’s leading market share.

• Sirius XM: No moat.
  The company’s in-vehicle experience can be mimicked by streaming providers that don’t need the satellite technology or customized radios.

Asset managers continue to face secular and cyclical headwinds. While most of the asset management firms in our coverage have tried to offset pressures, primarily through acquisitions or diversifying their product offerings, many continue to struggle to differentiate themselves. Still, companies with a stable of cost-competitive funds and adaptable business models are more likely to be better positioned for success.

• BlackRock: Wide moat.
  As the only wide-moat asset management firm that Morningstar covers, its focus on passive products, an ancillary business in technology and investment solutions, and greater attention to institutional investors truly separate the firm.

• T. Rowe Price and Cohen & Steers: Narrow moat.
  These two firms are more niche managers—the former focused heavily on the retirement channel and growth equities and the latter primarily running real estate investment trust-focused funds—generating better adjusted operating margins than the rest of the group.

The past few years have been challenging for apparel firms with the industry experiencing inconsistent results and compressed valuations since 2022—largely due to a series of challenges including general inflation and supply chain disruptions. Even so, there’s optimism for a turnaround in 2025 as inventory levels improve, discounting lessens, and new products stimulate demand.

• Dick’s Sporting Goods: Narrow moat.
  The retailer is a key destination for consumers and athletic apparel. Equipment vendors as consumers are drawn to its on-trend product assortment while vendors see Dick’s as a reliable partner for reaching and engaging with consumers.

• Gildan: Narrow moat.
  Although it’s difficult to attain a cost-based edge in the apparel industry, we believe that the firm’s vertically integrated supply chain has allowed it to gain one in the production and distribution of t-shirts and fleece for the US printwear industry.

Despite depleted savings, the appetite for gaming remains strong—particularly in iGaming wagering and sports betting. In fact, Q2 2024 industry sales were up 36%, spurred by sales growth in existing legalized states and recent state sports betting and iGaming launches. This trend is expected to continue, with US sports and iGaming industry sales anticipated to reach more than $35 billion by 2027.

• DraftKings: Narrow moat.
  We’re confident that neither competition nor regulatory forces will deter the company’s stout position within the US online gaming market.

• IDEX: Wide moat.
  The manufacturing company has a large installed base that’s protected by customer switching costs. Its long-standing reputation for quality and record of safety allow it to retain customer loyalty.

• Synopsys: Wide moat.
  We believe Synopsys remains well-positioned to navigate any short-term headwinds. Advancements in the company's AI toolkit are expected to boost demand and volumes while enhancing margins through operational efficiency.

• Nordson: Wide moat.
  Given that Nordson’s equipment often performs a critical function in the production process, we think that customers tend to replace components like for like and are reluctant to switch vendors.

• Sony Group: Wide moat.
  Over the past decade, Sony has shifted to an asset-light business model, focusing on content acquisition and developing recurring revenue businesses that enable long-term monetization from customers. We believe Sony Group’s current business portfolio that’s much stronger than before.

Many biotechnology firms enjoy economic moats. That said, we think most big biotech names continue to support wide moats, with excess returns more likely than not over the next 20 years. Strong innovation is countering headwinds from patent expirations, US drug pricing legislation, and pharmacy benefit managers negotiating leverage.

Here are some notable exceptions.

• Sobi: Narrow moat.
  The company’s growing portfolio of hematology and immunology products now warranted an upgrade.

• Biogen: Narrow moat.
  Downgraded because of patent pressure and high-risk neurology programs.

• Grifols: No moat.
  Downgraded because of increasing competition and poor economics around the firm's plasma business.

• Oracle: Wide moat.
  Following a years-long process of building out cloud infrastructure and application offerings, Oracle now boasts a comprehensive cloud-based product lineup. The cloud transition of its traditional on-premises customers should also serve as a tailwind to the company’s top-line growth in the future.

• Akamai: Narrow moat.
  We think the firm has continued to drive value through its security and computing businesses, enhancing the value of its legacy content delivery business and ultimately increasing the stickiness of its platform.

Most of the medtech firms that we cover dig economic moats through intangible assets and switching costs. In general, the firm's intangible assets are required to get noticed by customers. However, the addition of switching costs typically determine the moat width of medtech firms—none if switching costs are limited, narrow if switching costs are moderately long, and wide if switching costs are very long.

• Waters: Wide moat.
  We believe a wide moat surrounds the company’s analytical instrument business, consisting of liquid chromatography, mass spectrometry, and thermal analysis tools—leading Waters to enjoy profitability near the top of the life science market.

• Agilent: Wide moat.
  From an environmental, social, and governance perspective, Agilent faces limited risks and is one of the few companies in healthcare that could benefit from ESG-related efforts to exercise quality controls on the products humans ingest, such as food, water, and pharmaceuticals.

• Baxter: Narrow moat.
  Claiming top-tier positions in most of its product lines, Baxter typically competes with a concentrated group of peers, and we see a relatively long runway for the company to generate economic profits with its existing technology and pipeline of new products.

• Kraft Heinz: Narrow moat.
  Over the past five years, the firm has pursued durable efficiencies, elevated brand spending, enhanced its capabilities, and leveraged its scale to respond more nimbly to changing market conditions.

• Uber: Narrow moat.
  With autonomous vehicles (AVs, “robotaxis”) expected to play an increasingly impactful role in the rideshare industry, we believe that Uber is the only rideshare company with a vast network and critical mass—presenting a strong value proposition to potential AV partners who are looking to drive utilization.
• Lyft: No moat.
  Due to its poor core user base growth, lower engagement, and downward trend in incremental gross margins, Lyft lacks network effects as a moat source—the company’s diminutive scale also creates a significantly reduced value proposition and reduces the likelihood of AV partnerships in the future.

• Zoetis: Wide moat.
  Since its spinout from Pfizer in 2013, Zoetis has launched a string of revolutionary blockbusters that have made it become a leader in the higher-margin companion animal segment, and we anticipate its prowess in research and development to tee up new therapies in oncology, cardiology, and nephrology—all areas of undertreatment for pets.

• Elanco: No moat.
  While the pharmaceutical company is poised to potentially strengthen its presence in the pet market as it commercializes Zenrelia (dermatology) and Credelio Quattro (combination parasiticide) to challenge Zoetis' leadership in these categories, we doubt this will be enough to earn a moat.

Although we see the auto industry as not fully recovered from the pandemic and chip shortage, we expect growth through 2027 even if there’s a recession between now and then. And if macro pressures evaporate, it’s possible that 2025 could see more trade-in activity than normal.

Here are a couple of companies where this may not apply.

• BMW and Mercedes: No moat.
  While both companies rank among some of the most valuable brands globally, we believe that customers’ willingness to pay a premium for these brands will continue to decrease over time, especially given where their vehicles don’t match the technology offerings of premium Chinese competitors.

When you have a deeper understanding of what creates a lasting edge, it can be easier to show the value of your offerings.

Get unique insights where, when, and how you need them with Morningstar Direct Platform. Our applications now draw from unified data, analytics, and research—helping you make better, informed decisions. Explore even more exclusive data, including Morningstar Ratings, and build funds and portfolios that fit client needs.