This quintet of companies are all trading below their fair value and hold substantial competitive advantages, according to Morningstar’s Australia / New Zealand equity research team.

Four of the five have been on Morningstar’s best ideas list in prior months, but accounting software firm MYOB (ASX: MYOB) is a new addition. While its competitor from across the Tasman Sea, Xero (ASX: XRO) has attracted more attention in recent times, Morningstar equity analyst Gareth James believes MYOB compares very favourably.

"We are reassured by MYOB’s existing profits at a time when profit is almost a dirty word in the software sector.

"We also applaud management’s connected practice strategy, which essentially means creating a platform across which businesses, customers, advisors, and regulators can interact,” he says.

James notes that although MYOB has been a little slow in moving into cloud-based applications, “it is now quickly transitioning its customers to lucrative cloud-based subscription contracts”.

A key source of the company’s narrow moat rating are the high switching costs of its customers, which he believes are being pushed higher still by new features like Pay Super, PayDirect and smart bills. James also expects recent acquisitions and planned acquisitions to further strengthen its addressable market and competitive position.

Private hospitals

Two other narrow-moat-rated companies, this time within the healthcare space, remain on Morningstar’s best ideas list: private hospital operators Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO).

The largest incumbent in the space, Ramsay’s scale underpins “a sustainable competitive advantage that drives both cost advantage and a reasonable level of pricing power in negotiations with private health insurers,” according to Chris Kallos, senior equity analyst, Morningstar.

He believes government policies will continue to insulate private hospitals from substantial “funding-related disruptions” and also applauds Ramsay’s move into community pharmacy.

Australia’s second-largest private hospital operator, in terms of market capitalisation, Healthscope is a less diversified business with earnings largely driven by the domestic hospital portfolio. "As a result, it is more reliant on timely completion and ramp of its ongoing brownfield projects,” Kallos says. "As such, the slower-than-expected ramp-up in volume at several sites in the state of Victoria disappointed at the full-year result.”

However, he is encouraged by progress being made on other significant sites, including Sydney’s Northern Beaches Hospital project and “views the shares as significantly undervalued at current levels”.

Distinguished from other companies in this list by a high level of uncertainty around its fair value, Morningstar’s senior banks analyst David Ellis nonetheless maintains his long-term conviction in general insurer QBE Insurance (ASX: QBE).

“In the short term, we expect more earnings volatility, but from 2019 we forecast steady and consistent earnings growth.

“We believe in the QBE turnaround story based on improving macro momentum with a long-awaited upturn in global insurance rates, stronger economic conditions in the US and Europe, operational cost savings, and increasing global interest rates.,” Ellis says.

He believes QBE is capable of reporting mid-cycle cash profits of around $1.1 billion per year, and says “strong cash conversion, higher dividends, and completion of the buyback should underpin investor interest”.

Morningstar research also indicates the somewhat out-of-favour telco company Telstra (ASX: TLS) is considerably under-valued at current levels. According to equity analyst Brian Han: “investors are preoccupied with a number of risks facing the group”.

Though Han concedes that competition is intensifying for Telstra, he reminds investors this is happening across all segments within the telco sector.

“We believe Telstra boasts the strength to compete, given a sustainable cost advantage from unrivalled scale, infrastructure footprint, and consistent capital spending to maintain this competitive edge.

“At the current price, the market is assuming that Telstra fails to plug the $3 billion earnings hole from the National Broadband Network--an excessively bearish view, given the group’s competitive position and its solid record of replacing lost earnings over the past decade,” Han says.

The full list of 10 Best Stock Ideas, updated monthly, is available to Morningstar Premium subscribers.

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Glenn Freeman is a senior editor at Morningstar.

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