DIARY OF A PORTFOLIO MANAGER
December 31, 2025
“In business, I look for economic castles protected by unbreachable 'moats'."
- Warren Buffett
Good afternoon,
Here we are, wrapping up 2025 and heading in to 2026. I am off to Toronto next week for the 2026 edition of RBC’s “Portfolio Management Conference”. Three days of chats and presentations. I will share notes from that in my next missive to you. For today, though, I have a question:
What Is an Economic Moat?
Some companies seem to have an uncanny ability to fend off rivals and maintain their market dominance year after year. This phenomenon, known as an "economic moat," doesn't just keep rivals at bay but also seems to separate successful firms from those that fail.
The term was first popularized by legendary investor Warren Buffett and it's perhaps his favorite metaphor. He’s used it in dozens of investor talks going back decades. "Economic moat" draws an evocative parallel with the water-filled trenches that protected medieval castles. In the business world, these moats characterize sustainable competitive advantages that shield a company's profits from marauding competitors.
If you and I decide to go into business together and become determined to start a cell phone network, Bell and Telus would hardly be worried. Where would we even begin to make a dent in their existing network? Same goes with CP and CN Rail if we opted to start a railway enterprise instead.
The Morningstar Economic Moat Rating
One of the external tools that we use is Morningstar and their intrinsic value calculations. They also have an Economic Moat Rating.
Morningstar identified five sources that build and widen a moat:
- Switching costs are obstacles that keep customers from changing between products, like from one company’s product to a competitor’s.
- Network effects occur when the value of a good or service increases for both new and existing users as more people use it.
- Intangible assets are things such as patents, government licenses, and brand identity that keep a company ahead and competitors at bay.
- A company with a cost advantage can produce goods or services at a lower cost, allowing it to undercut its competitors or achieve higher profitability.
- Efficient scale benefits companies operating in a market that only supports one or a few competitors, limiting rivalry.
If we can expect a company’s competitive advantage to last more than 20 years, we consider it as having a wide moat. If it can fend off rivals for 10 years, it has a narrow moat. If a competitive advantage doesn’t exist or may prove fleeting, there’s no moat.
When searching for undervalued companies, those with narrow or wide economic moats often offer attractive return potential. The Morningstar Economic Moat Rating can help us identify those companies to provide superior long-term returns.
Perhaps, down the road, I will share some insights from Morningstar and their fair value estimates and how we make use of those. My guess is that you can’t wait.
In the meantime, I hope that you have a very Happy New Year!
