Finding companies with long-term commercial advantages over their rivals is hard enough. Finding them at bargain prices is harder still. Morningstar claims to have done the trick, identifying enough examples of such businesses to fill an index of stocks called Wide Moat Focus.
The odd name refers to American companies with "large sustainable competitive advantages," the independent research firm says in a report explaining the index and the thinking and methodology behind it. The index holds the 20 stocks of these companies with wide moats that trade at the cheapest price relative to their intrinsic value, as judged by Morningstar's team of analysts.
The companies in Wide Moat Focus - which has its own exchange-traded note (WMW), similar to an exchange-traded fund - tend to be big but not immense, with an average market value of more than $33 billion, and a slight tilt toward growth and away from value, as defined by the analysts.
The bigger names in the index include General Electric (GE); Procter & Gamble (PG); American Express (AXP); Visa (V); Cisco Systems (CSCO) and several health care companies - Merck (MRK), Pfizer (PFE), Johnson & Johnson (JNJ) and Abbott Laboratories (ABT).
The rest of the index comprises four companies tied to the real estate market - two producers of construction supplies, Martin Marietta Materials (MLM) and Vulcan Materials (VMC); the developer St. Joe (JOE) and the home-improvement retailer Lowe's (LOW) - the semiconductor equipment maker Applied Materials (AMAT); Sysco (SYY), a food distributor; the asset manager BlackRock (BLK); the consumer-goods distributor Avon Products (AVP); Western Union (WU), a money transfer firm; Zimmer Holdings (ZMH), a maker of medical devices, and the power generator Exelon (EXC).
"If we have some skill at identifying businesses with competitive advantages, and if we have some skill at valuing the shares of those businesses, then a portfolio of cheap wide-moat stocks should outperform the market generally and our wide-moat universe specifically. I am happy to report that, so far, this has indeed been the case. A portfolio of the wide-moat stocks we view as being the most mispriced has generated substantially higher returns than both the S&P 500 and our overall wide-moat universe."
In the five turbulent years through March 31, Wide Moat Focus has produced an annualized gain of 9.1 percent, compared to 5.1 percent for Morningstar's broader, equally weighted Wide Moat Index and 2.6 percent for the S&P 500. The outperformance holds up well over three years, but over one year, the order is reversed; Wide Moat Focus gained 13.0 percent, Wide Moat was up 14.3 percent, and the S&P 500 did best of all, rising 15.7 percent.
The comparative weakness over one year, a very good one for stocks over all, might be a blessing in disguise and enhance the case for holding some of the stocks in Wide Moat Focus or all of them through the ETF. Stability and safety are hallmarks of the companies in the index. Those qualities are less in demand during times like these, when investors appear inclined to throw caution to the wind. But with stocks near their recovery highs, they could come back into fashion in a hurry.