Chapter 7Do Moat Ratings Predict Stock Returns?

Contributed by Warren Miller, head of quantitative research at Morningstar

Analyzing competitive strengths and weaknesses can undoubtedly help management teams make better strategic decisions, but can this type of research also help investors make better choices and achieve better outcomes? In other words, is it worth precious time to dive deep into the intricacies of the moat framework? In this chapter, we use some simple statistical analysis to examine what our moat ratings can tell us about stock returns. We launched these ratings in 2002, which gives us more than a decade’s worth of data to analyze. Of course, the following studies show how the moat ratings have performed in the past, and as always, there is no guarantee this performance will continue into the future.

Through our research, we’ve found that wide-moat stocks exhibit less downside risk and less upside potential. In times of market fear or distress, wide-moat stocks outperform no-moat stocks, but then underperform when risk aversion subsides. The evidence isn’t quite strong enough to claim that all wide-moat stocks generate excess risk-adjusted returns, but we do find that undervalued wide-moat stocks have done so. We think it’s safe to say, then, that the moat rating is a valuable risk-management and security-selection tool, especially when used in conjunction with valuation-based metrics.

The most direct way to look at the performance of moat ratings is to segment ...

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