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Morningstar | Investing in the Efficient Scale Moat Source

Efficient scale typically applies to firms that serve a market of limited size, in which potential competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital. Although we observe efficient scale across nearly every sector, it is most common in highly regulated and capital-intensive industries, such as regulated utilities, telecom services, midstream oil and gas, REITs, and railroads.

Compared with companies that benefit from other moat sources, efficient scale firms have historically generated lower returns on invested capital, owing to high capital intensity and the notion that regulation can limit upside for profitability. Regardless, the durability of economic profit is more important than its magnitude when assigning moat ratings. Accordingly, even if economic profit spreads can be thin for efficient scale companies, we still expect economic profits to prove durable into the future. Therefore, we still see plenty of investment opportunities among firms with efficient scale as a moat source.

The midstream oil and gas, telecom services, and utilities sectors hold the most undervalued investment opportunities for firms with efficient scale as a moat source, including many of our Best Ideas. This report highlights our top picks among firms with the efficient scale moat source and recaps the differentiated research we've published over the past year to substantiate our view.

We see many intriguing investment ideas that have efficient scale as a moat source, including some of our Best Ideas. For a deeper dive into the investment opportunities with the efficient scale economic moat source, refer to our October 2018 report, "Investing in the Efficient Scale Moat Source."

For a deeper dive into the efficient scale economic moat source, refer to our September 2018 Economic Moat Source Series: Efficient Scale.