If the stock market were to close for ten years from tomorrow, would you be happy owning the companies in your portfolio until it reopened? Or would you have sleepless nights?

Warren Buffett once offered this as a litmus test of an investment's quality.

According to Buffett, investors should focus on owning companies almost certain to still enjoy super strong competitive positions – and most likely, higher profits – several years from now. In his opinion, those are the kind of companies where the value of your ownership stake is most likely to grow over time.

Most companies don’t offer investors much certainty in that regard. Their industries are too competitive or fast-changing. But some companies – like the one starring in this article – seem far more likely to dominate their end markets for years to come.

A Morningstar Wide Moat rating is perhaps the best filter for companies more likely to enjoy strong competitive positions several years from now. That’s because a Wide Moat rating means our analysts thinks the company can earn excess returns on investment (in the form of profits) for at least 20 years.

Only 20 of Australia’s 2000+ listed companies have achieved this rating. And while there are some daunting moats on that list, I think it’s hard to argue against ASX Ltd having one of the widest.

A monopoly on vital parts of Australia’s financial system

ASX Ltd (ASX: ASX) is Australia’s leading provider of equity listings, settlement, clearing and trading.

It has an effective monopoly on equity listings in Australia with over 95% market share. ASX’s catchment zone also extends to New Zealand, with New Zealand based companies cross listing on the ASX equating to around a third of total companies listed on the New Zealand Stock Exchange.

Our ASX analyst Roy van Keulen has given ASX a Wide Moat rating due to network effects in its settlement, trading and clearing businesses. A network effect is where a company’s products and services are improved by every additional user. This generally eventually leads to a winner-takes-most competitive environment.

In ASX’s case, higher trading volume leads to better liquidity, lower costs and tighter bid-ask spreads for traders. We also think that ASX benefits from these network effects in its technology and data business, which can offer products and services based on proprietary data generated by ASX markets.

You can read more about network effects and other ASX listed companies that benefit from them here.

A weak few years for ASX shares

ASX shares fell in June after management guided to higher-than-expected investments into the business. While Van Keulen admits this will see ASX’s profit margins take longer to recover, he does not share the market’s concerns that costs have found a new, higher floor.

A recent recovery has erased much of June's fall. But there's no getting around the fact that it's been a poor few years for ASX shares. They are down by roughly 25% over the past five years.

This weakness is partly due to concerns that ASX’s decision to shelve long-promised upgrades to its settlement system could cause regulators to seek greater competition.

Van Keulen thinks the chances of this are reduced by the fact that equity settlements and clearing are hardly hot-button issues for most of the Australian electorate. Instead, Van Keulen thinks it is more likely that the Australian financial system continues to consolidate around ASX due to its monopoly-like market share and the network effects mentioned earlier.

Van Keulen also sees two underappreciated sources of potential growth for ASX Ltd.

The first is that changing interest rates and geopolitical tensions could lead to increased market volatility. As volatility stems from and stimulates higher trading volumes, ASX could generate higher revenues as the facilitator and toll-collector on those trades. These sources of potential volatility are especially relevant to ASX because of the Australian market’s high exposure to materials and energy.

While more volatility could impact the number of new listings, Van Keulen thinks that huge investments in the net zero transition – and the vital role that metals and natural gas will play in the transition – could outweigh this and lead to listings growth.

As such, the ASX could prove a beneficiary of the huge investments needed in natural resource capacity without putting down any extra capital itself.

Key things to watch out for

A key difference between investing and speculation is a focus on the underlying business rather than stock price gyrations. For ASX Ltd, two things to watch out for are its ability to reign in its costs and stay on the right side of regulators.

Van Keulen thinks ASX has erred recently in securing and growing one of its key moat sources, namely the intangible of a supportive regulatory environment that grants it various legal monopolies.

Although he expects the impact to remain limited due to ASX’s network effects, he faults ASX’s failure to secure its regulatory moat and thinks it is vital that ASX replaces its clearing system with something that regulators and market participants are satisfied with.

Shares currently look undervalued

Morningstar's Roy Van Keulen has maintained his Fair Value estimate for ASX Ltd at $75 per share. This is based on revenue growth assumptions of 6% per year for the next decade and higher profit margins as investments in the clearing upgrade wind down.

At a price of around $63 per share, ASX Ltd trades roughly 15% below Morningstar's Fair Value estimate. Given the company's Wide Moat rating and Uncertainty rating of Low, the shares currently command a four-star rating. At a price of $60 or below it would fall in to five-star territory.

Before considering a stock or fund purchase, it is vital to set out a deliberate investing strategy that is suitable for your goals. Go here to read a step by step guide to doing this.

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

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