The Powerful Relationship of Technology and Economic Moats

COMMENTARY

Market Insight

EATHERBIE CAPITAL

EATHERBIE CAPITAL

THE POWERFUL RELATIONSHIP OF TECHNOLOGYAND ECONOMIC MOATS

Internet-related technologies and other digital innovations are racing through the economy and helping leading businesses disrupt their respective industries by developing new products and services. This important trend is particularly noteworthy among smaller, nimble businesses that are quickly capturing market share and displacing legacy companies by launching products that are changing business processes and virtually every aspect of our daily lives. In the process, leading companies are strengthening their economic moats, which may make them potentially attractive investment opportunities. An economic moat represents a company’s sustainable competitive advantage. At Weatherbie Capital, we conduct in-depth fundamental research when selecting smaller cap companies for our portfolios. Based on our research, we believe smaller companies that are either pursuing untapped niches or creating new niches with innovative products have strong potential to outperform. As rapidly growing businesses that are investing in new technology, many of these companies are also expanding their moats. On a broader scale, the benefits of moats among smaller companies are not readily apparent because the category of companies is less closely followed by analysts at broker-dealers or other research firms. However, the power of economic moats is illustrated by large companies where ample data exists. According to Morningstar, equities of larger companies with wide moats have outperformed over the past one, three and five years (See Fig. 1). In our view, the significance of moats and the fact that moats are not readily apparent among smaller companies underscores the importance of conducting fundamental research when investing in smaller cap stocks. According to Morningstar, there are five factors in determining a moat: switching costs (impediments that prevent customers from switching from one product to

Matt Weatherbie, CFA CH I E F E X ECU T I V E O F F I C E R CO - CH I E F I NV E S TMEN T O F F I C E R WE AT H E RB I E CA P I TA L , L LC

H. George Dai, Ph.D. S EN I OR MANAG I NG D I R ECTOR CO - CH I E F I NV E S TMEN T O F F I C E R WE AT H E RB I E CA P I TA L , L LC

Figure 1: Wide Moats, Wide Outperformance (%)

Joshua D. Bennett, CFA S EN I OR MANAG I NG D I R ECTOR D I R ECTOR O F R E S E A RCH WE AT H E RB I E CA P I TA L , L LC

20.66

17.10

14.87

13.58

13.49

11.63

9.96

6.57

Performance

1.58

5 Years

1 Year

3 Years

Morningstar Wide Moat Index

S&P 500 Index

Morningstar No Moat Index

Source: Morningstar, Inc. as of 4/30/19. Note: Returns for greater than one year are annualized.

Past performance is not an indication or guarantee of future results.

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