Chart of the Week: AI proving a threat to company moats
The latest insights on AI from our equity research team.
Mentioned: CrowdStrike Holdings Inc Class A (CRWD), Cloudflare Inc (NET), Booking Holdings Inc (BKNG)
This week’s charts come from Eric Compton and Mark Giarelli’s latest report Moat Ratings Guidebook Amid AI Disruption.
There has been a lot of indiscriminate selling across sectors amid AI-related fears, with correlations among many otherwise seemingly unrelated companies increasing.
Getting moats right is a key part of our long-term, focused methodology, and to ensure we are getting our calls as right as possible, we reviewed 132 companies that seemed most susceptible to AI disruption.
The Morningstar Moat rating
The moat rating signifies the ability of a company to hold competitors at bay through a sustainable competitive advantage. We assign a Wide, Narrow, and No moat ranking to each stock under its coverage.
- A Wide Moat rating means our analyst thinks the company enjoys structural advantages that are more likely than not to support excess profits and returns on investment for at least 20 years.
- A Narrow Moat means the company appears to have durable advantages likely to underpin excess returns for at least ten years. However, our analysts have some doubts about the advantage lasting for 20 years or more.
- A No Moat rating means our analysts think the company lacks a durable competitive advantage. Therefore they are unlikely to earn excess returns on capital for a decade or more.
An update amid disruption
Of the 132 companies reviewed, we downgraded 22 wide moats (20 to narrow, two to none) and 18 narrow moats (from narrow to none). However, we maintained the moat rating for most of the companies we reviewed, and we even upgraded two narrow-moat companies to wide-moat (CrowdStrike and Cloudflare) due to their positioning in the infrastructure layer and their network effects.
Does AI create risk? Absolutely. Are those risks equal across all companies, and are there no software firms with moats remaining? Absolutely not.
We do not buy into ‛Everything Non-AI is Dead’
We do not think AI is a universal disruptor of all competitive advantages; instead, we view it as a sorting mechanism. Most companies’ moats remained unchanged, but the number of downgrades was significant.
AI will challenge companies whose strengths depend on workflow frictions, labour intensity, and application stickiness, while preserving - or even strengthening - businesses built around infrastructure, proprietary data, network effects, or specialised domain workflows.
Interestingly, many of the companies downgraded still have large installed bases, highly utilised products, and/or important customer relationships. In other words, it was not black and white, even for many of the downgraded companies. That said, we do think AI materially decreases long-term visibility and can weaken the durability of existing advantages by making parts of the workflow layer easier to replicate, automate, or less dependent on human seat growth.
Network effects were the most resilient moat source
Companies with network effects as a moat source saw the fewest relative number of downgrades. The intuition here is relatively straightforward: Network effects are not based on the product’s technology; they are based on the strength of the network. Therefore, it stands to reason that even as technologies change, the network itself may still be hard to disrupt.
Classic examples here included payment networks, exchanges, and even travel networks like Booking Holdings, where we thought the core of the business was reliant on the strength of the travel network and the ability to aggregate the long tail of hotel supply, something that technology innovations like AI do not necessarily solve for.
Enterprise software and IT services had the most downgrades
Downgrades were concentrated among more horizontally focused enterprise software (such as CRM offerings), IT services, payroll processing, and select vertical-market SaaS and information services businesses. We found the most resilience in complex engineering software workflows, cybersecurity, financial infrastructure firms, and offerings with unique data and/or network effect assets.
Half of the companies we rated as wide moat after this exercise exhibit network effects. Other key sources of resilience included regulatory barriers to change or other switching cost barriers, and unique data assets.
