How a Moat Stock Gets Its Economic Moat

February 22, 2022

Read Time 1 MIN

Morningstar has identified five sources of economic moat: switching costs, intangible assets, network effect, cost advantage and efficient scale.

Moat investing is based on a simple concept: invest in companies with sustainable competitive advantages trading at attractive valuations. One of the first steps in implementing this approach is finding companies with a moat.

A company’s moat refers to its ability to maintain the competitive advantages that are expected to help it fend off competition and maintain profitability into the future. Morningstar has identified five sources of moat:

Sources of Moat	Description
Switching Costs	Switching costs give a company pricing power by locking customers into its unique ecosystem. Beyond the expense of moving, they can also be measured by the effort, time, and psychological toll of switching to a competitor.
Intangible Assets	Though not always easy to quantify, intangible assets may include brand recognition, patents, and regulatory licenses. They may prevent competitors from duplicating products or allow a company to charge premium pricing.
Network Effect	A network effect is present when the value of a product or service grows as its user base expands. Each additional customer increases the product’s or service’s value exponentially.
Cost Advantage	Companies that are able to produce products or services at lower costs than competitors are often able to sell at the same price as competition and gather excess profit, or have the option to undercut competition.
Efficient Scale	In a market limited in size, potential new competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital.

Explore how each of these attributes may contribute to a company’s moat and learn more about companies that showcase these sources of moat in our Five Sources of Moat series:

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