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Why Moats Matter: The Morningstar Approach to Stock Investing by Heather Brilliant, Elizabeth Collins

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Chapter 3Why Moat Trends Matter

Contributed by Stephen Ellis, a member of Morningstar’s Economic Moat Committee and head of Financial Services equity research at Morningstar

By now you have a good working knowledge of economic moats and what it takes for companies to build them. But there’s another important facet of moats that we haven’t much touched on—the direction they’re heading. Moat ratings, while forward looking, are static, and don’t indicate whether a company’s competitive position is improving or declining. That’s why in 2009, we introduced moat trend ratings to supplement our economic moat ratings. The trend ratings convey the direction firms are heading, in terms of their competitive advantages. We believe this is a very important additional piece of information. Moat ratings can tell you the width of a company’s current moat, but trend ratings tell you if that moat is holding up well, is getting even stronger, or is in danger of being filled in by a rampaging horde of invaders.

Trend ratings recognize that corporations evolve and that moats grow, mature, and eventually die. In other words, economic moats have a life cycle. As such, whenever we assign a moat rating, we also assign a trend rating: positive when competitive advantages are improving, negative when they’re declining, and stable when we don’t see much movement one way or the other. In mid-2013, about 16% of the companies we cover had negative trends, while just 8% showed positive trends. This means that ...

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