How to Invest in Wide-Moat Stocks

Stocks can potentially be a risky investment, so the concept of stocks that are protected as if by a castle moat is appealing to many investors. In this guide, moneyland.ch explains what wide-moat stocks are, and how to invest in them as a Swiss investor.

What is a wide-moat stock?

The term wide-moat stock was coined by American investor Warren Buffet. The metaphor describes companies that have a large competitive advantage that acts protects them from competition in the same way that a moat protects a castle. Stocks that have this designation promise higher investment security. For that reason, they are often used for buy-and-hold investment strategies.

Wide-moat companies typically share these features:

• A dominant market position
• High pricing power
• A business model that is difficult to replicate
• A strong brand (or brands)
• Strong customer relationships

Which companies qualify as wide-moat stocks

The companies that are considered examples of wide-moat stocks vary depending on the source. Examples of companies that are broadly accepted as wide-moat stocks include:

• Microsoft: The tech giant enjoys a dominant position thanks to its software applications and its Windows operating system.
• Alphabet:  The company’s Google search engine dominates the market for Internet searches in most countries.
• Coca-Cola: While many companies compete in the beverages market, Coca Cola has built a globally-recognized brand and strong supply and retail chains.
• Apple:  Apple benefits from an unmistakable brand and a large international fan base.
• Union Pacific:  The US railway company operates its own railway network, which makes it difficult for new players to enter the market.

Four Swiss companies – Richemont, Julius Bär, Roche, and Nestlé – are included in the Morningstar Global Wide Moat Focus index.

Are there any indexes for wide-moat stocks?

There are several indexes that track wide-moat stocks. Financial services provider Morningstar publishes four different wide-moat stock indexes which differ in various aspects. Only one of these is a global stock index, while the other three focus entirely on US stocks.

The Solactive Brand Finance Global Brands Index does not specifically refer to wide-moat stocks in its title or description. However, according to its publisher the index tracks the world’s most valuable brands. De facto, many of these are wide-moat stocks.

Table 1: Overview of wide-moat stock indexes

Source: Index publishers. Date: July 5, 2024.

A point that stands out when looking at the makeup of the Morningstar Global Wide Moat Focus index: Although the index includes just 70 stocks, the ten most heavily weighted stocks together only make up around 23 percent of the index. That means the performance is not dominated by just a few stocks. For the sake of comparison, while the global MSCI World index includes more than 1400 different stocks, the 10 most heavily weighted stocks make up 25 percent of the index (as per July 2024).

Table 2: The 10 most heavily weighted stocks in the Morningstar Global Wide Moat Focus index

Source: Index publisher. Date: July 05, 2024.

Can I invest in wide-moat stocks using ETFs?

Yes, there are exchange-traded funds (ETFs) that track the indexes listed above. ETFs are traded on stock exchanges just like the stocks of companies. You can buy and sell shares in ETFs at any time during trading hours using a stock broker. The checklist for choosing the right ETF explains what you should pay attention to.

Table 3: Overview wide-moat ETFs

Sources: Fund managers. Date: July 8, 2024.

What are the risks of investing in wide-moat stocks?

Investing in stocks and ETFs always comes with a risk of loss. But there are several additional risks that are specific to wide-moat stocks:

• Lack of innovation: Wide-moat companies can run the risk of overestimating their market position. If this happens, the company’s innovative potential may suffer. Over time, the company may lose its competitive advantage.
• Regulations: Companies with very dominant market positions may be targeted by political measures. In extreme cases, this could result in the company being broken up into smaller companies.
• Poor diversification: ETFs that invest in wide-moat stocks are not particularly well diversified. Most invest in less than 100 different stocks. Placing all your money in just a few individual stocks increases the risk of loss.

How well do wide-moat stocks perform?

There is no way to predict how wide-moat stocks will perform in the future. Predicting the future returns of stocks or ETFs is impossible. The only information we have about the performance of wide-moat stocks comes from their past performance. The historical data for the global VanEck Morningstar Global Wide Moat UCITS ETF shows that its performance since it launched in 2020 has been poorer than that of global ETFs based on the FTSE All-World Index.

Table 4: Global wide-moat ETF performance compared

Source: Justetf.com. Term used for comparison: July 7, 2020 - July 5, 2024. Date: July 8, 2024.

It is important to bear in mind that stocks and ETFs are best-suited to long investment terms – generally periods much longer than the four years used for the comparison. Over longer terms, the performance can radically differ from the results shown in Table 4.

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Checklist for choosing the right ETF
Checklist for choosing the right stock