Companies with durable competitive advantages, or economic moats, have performed well over the past year. Key to these returns are attractive starting valuations. The combination of a moat with an undervalued stock has had a long track record of outperformance. Morningstar analysts believe that for the best long-term results, investors are best served by considering companies’ moats alongside their valuations.
This can be seen with the Morningstar Wide Moat Focus Index, a collection of the lowest-priced companies with analyst-assessed competitive advantages that are expected to last more than 20 years. The index has returned twice as much as the Morningstar US Market Index over the past 20 years. Over the past decade, it’s outperformed the broader market by 40 percentage points. “To find stocks that are most likely to outperform, the key is to combine high quality with attractive price,” says Morningstar equity strategist Allen Good. “An economic moat in itself won’t result in outperformance.”
The ‘Magnificent Seven’ and Moat Stocks
This dynamic can even be seen in the stock market rally of the past year. Much of the attention has been on the stocks known as the Magnificent Seven: Nvidia NVDA, Meta Platforms META, Apple AAPL, Amazon.com AMZN, Microsoft MSFT, Alphabet GOOGL/GOOG, and Tesla TSLA. Six of these stocks have wide moats—the exception is narrow-moat Tesla. At the start of 2023, five of the six wide-moat Magnificent Seven stocks were in the Wide Moat Focus Index, with a total weight of 11%. As they rallied, Nvidia and Meta were booted from the index, while Amazon and Microsoft saw a decrease in weight. But these stocks continued to soar, causing the index to lag.
Over the past year, wide-moat stocks have performed very well. The Morningstar Wide Moat Composite Index—which tracks all the stocks in the US market with wide moats, regardless of their valuations—gained 30.3%. This outpaced the US Market Index, which gained 19.9%. The Wide Moat Focus Index did not see quite the same success, gaining only 16.4%. Still, it’s outperformed narrow-moat and no-moat stocks over this time. Narrow-moat stocks were up 12.9%, and stocks without moats were up 1.9%.