30% of the S&P 500 Is Mag 7 Tech Stocks, but This ETF Refuses to Own a Single One

The Magnificent 7 AI tech stocks have served as the rocket fuel propelling the S&P 500 on its bull run over the past few years. However, there is a risk in overweighting on high-flying stocks that have all made their gains based on developments in the same sector. The Magnificent 7’s gains make up more than half of the average 16% YTD returns on the S&P 500. Without them, those S&P YTD gains drop to an impressive but decidedly more earth-bound 7%. 

Diversification is the overarching warning to these investors, but how to choose what companies, or better yet, which ETFs might offer safe gains without Nvidia (NASDAQ: NVDA), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), and other Magnificent 7 stocks powering their engines? 

Morningstar is highly regarded for its research into the financial markets and its various investment funds, structures, and platforms. One unique rating category that Morningstar has devised for stocks is its “Economic Moat”. The calculation is designed to identify and quantify a company’s competitive advantages and its ability to generate substantial returns over an extended period. The VanEck Morningstar Wide Moat ETF (CBOE: MOAT) gives investors an opportunity to directly invest in an ETF that tracks the Morningstar Wide Moat Focus Index. 

The Morningstar Moats

Morningstar moats focus on a series of criteria that qualify competitive advantages for companies and their projected duration lifespans.

The concept behind Morningstar’s Moat criteria attempts to quantify specific competitive advantages of companies that will enable them to generate significant returns in the market for investors. While strong profits are first and foremost on the checklist, sustainability and track record for resilience are also key factors in the assessment. As such, the economic advantages can be broken down along the follow lines:

• Intangible Assets: Brand identity, patents, trademarks, and other unique characteristics in the market place that make it difficult for rivals to compete head-to-head.
• Cost Advantages: Offering goods or services at lower prices at a lower cost, resulting in higher margin or more appealing prices to customers in the market.
• Switching Obstacles: Circumstances that maintain customer loyalty through barriers to switching, which may include financial penalties, interim loss of service or product unavailability, or cumbersome procedures.
• Market Scale: Most markets have a saturation point of demand that is reached when the major producers have streamlined their production of goods or services to peak efficiency, creating an obstacle for further competitors to enter the arena.
• Network Snowball: The momentum of growth that occurs when a service or product’s value is recognized to the point where its popularity spreads virally to further its sector dominance. 

There are three Morningstar Moat ratings:

• Wide – meaning a strong competitive advantage with at least a 20 year lifespan
• Narrow – a small, but not substantial competitive advantage with a prospective 1- year lifespan
• No Moat – either a currently unsustainable small competitive advantage or none to any measurably significant degree

Moats are most often utilized in Morningstar long-term investment analyses, especially based on Return On Invested Capital (ROIC) compared to cost of capital. Identifying companies with a consistent record of excess returns is the goal. Morningstar ETFs and indexes most often incorporate moats as part of its overall analysis criteria. 

VanEck Morningstar Wide Moat ETF

Thermo Fisher Scientific is the second largest stock holding in the MOAT portfolio.

Although there are several ETFs that track wide moat companies, the VanEck Morningstar Wide Moat ETF is one of the only ETFs dedicated to Morningstar’s Wide Moat Index. At the time of this writing, its year-to-date gains are 11.39%, roughly 430 basis points ahead of an S&P 500 with Magnificent 7 stock returns mathematically subtracted. More importantly, the stocks in MOAT have long histories of competitive advantage in each of their respective sectors, making the chances of large turnover in the index smaller than what might occur in other indexes.

An overview appears below:

Many of the top 10 largest MOAT holdings are household names from the S&P 500 but are notably not involved with AI to any sizable degree. Nevertheless, they are notable for having their own respective proprietary niche advantages in each of their respective sectors.

• Applied Materials (NASDAQ: AMAT) – 3.56%

• Thermo Fisher Scientific (NYSE: TMO) – 3.15%

• Merck & Co. (NYSE: MRK) – 3.03%

• Huntington Ingalls Industries (NYSE: HII) – 2.98%

• Agilent Technologies (NYSE: A) – 2.98%

• Amgen Inc. (NASDAQ: AMGN) – 2.87%

• Estee Lauder Cos. (NYSE: EL) – 2.82%

• West Pharmaceutical Services (NYSE: WST) – 2.73%

• Danaher Corp (NYSE: DHR) – 2.71%
• GE Healthcare (NASDAQ: GEHC) – 2.50%

The Moat concept is an analytical construct that helps to avoid trends and identifies companies that are impervious to fads or bandwagon jumping in favor of solid businesses with long-range staying power. If lower volatility and long-term, sustainable growth is an investment goal, MOAT is an ETF to put on the radar.