A key item in a stock wish list
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Christine St Anne is Morningstar's online editor. You can follow her on Twitter @MstarChristine
The collapse of a number of junior miners due to falling iron-ore prices dominated this week's headlines in the financial press.
Junior miners face production costs that are higher than those of their larger counterparts and this makes them more vulnerable to commodity price movements.
It's a common scenario, but in the heyday of a mining boom investors can often be attracted to the potential for huge returns on the back of rising commodity prices.
But when it comes to investing for the long term, steady performance is what delivers the returns.
Assessing whether a company has the ability to deliver consistent returns is a key part of Morningstar's research methodology. At the heart of this methodology is the moat rating.
Moats matter because they can really help identify high-quality businesses that can make great long-term investments, Morningstar Australasia co-chief executive Heather Brilliant says in a recent video.
In the video, Brilliant outlines the five factors that determine a company's moat: intangible assets; switching costs; cost advantage; network effect; and efficient scale.
Brilliant, who has co-authored the book Why Moats Matter, explains that a moat is a sustainable competitive advantage.
"We're just trying to capture the idea that a company can earn excess returns for a long period into the future," she says.
Morningstar Australasia manager of operations equity and credit, Gareth James, likes to think of moats as a key item in a "wish list" of what you would like in a stock.
"The decision to invest in a company is based on a number of factors such as a cheap price, the profitability of a business, a strong balance sheet and a good management team," he says.
"Those factors are part of your wish list. You also want to generate returns in excess of a company's invested capital and those excess returns need to be sustainable. A moat is a key part of this stock wish list."
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