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By Carla Fried

The Morningstar Wide Moat Focus Index tracks a select universe of 20 stocks that Morningstar's highly-rated equity analyst group deems have a strong competitive advantage and currently trade at a compelling valuation.

Over the past five years the 13% annualized total return for the index is more than double the total return of the S&P 500. A little more than a year ago an ETF following the index launched -- Market Vectors Wide Moat (NYSEARCA:MOAT). The $232 million ETF manages to match the index in its short 14-month history, despite the drag of a 0.49% annual expense ratio.

MOAT Total Return Price Chart

MOAT Total Return Price data by YCharts

The folks at Morningstar (Full Disclosure: Morningstar is an investor in YCharts) just announced the latest quarterly rebalancing of the index (and thus the ETF). Eight stocks were booted from the index, including Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC), replaced by another eight companies including Facebook (NASDAQ:FB), eBay (NASDAQ:EBAY) and money management firm Franklin Resources (NYSE:BEN).

More on the portfolio changes in a sec; understanding the underpinnings of Morningstar's strategy is in order.

A moat is a competitive advantage. For a quick master class on the topic, check out the 2007 Berkshire Hathaway (BRK.B) shareholder letter; chairman Warren Buffett spills some valuable ink explaining.

Morningstar looks for five different moats: Intangible Assets, Switching Costs, Network Effect, Cost Advantage and Efficient Scale. (You can read more here:)

The 1,200 or so companies that are tracked by Morningstar analysts are assigned one of three moat ratings: No Moat, Narrow Moat and Wide Moat. Wide Moat stocks must have at least one of the attributes.

Morningstar isn't interested in short-term moats. It crunches the numbers in pursuit of companies it estimates will still be producing high return on invested capital (ROIC) 20 years out.

Apple (NASDAQ:AAPL) is producing strong ROIC right now. But given the vagaries of consumer taste, somewhat low switching costs (when it's time for an upgrade it's not a big deal to ditch your iPhone for the Samsung Galaxy) and the disruptive nature of technology advances, it's hard to extrapolate with any certainty where Apple will be 20 years from now. Morningstar currently rates Apple Narrow Moat. Contrast Apple's market pressures with that of a Qualcomm (NASDAQ:QCOM) or Oracle (NYSE:ORCL)-both wide moat stocks-where the switching costs for companies using their products is high in terms of both actual cost and any employee re-training.

You can do more detailed investment analysis on YCharts.

Morningstar culls its list of 150 or so wide-moat stocks into the 20-stock portfolio for the index based on valuation. Morningstar has a proprietary analysis system that assigns a fair value price to stocks it covers. Stocks trading at the widest discount to their fair value are the most compelling.

Eight stocks were kicked out of the index this quarter; all eight maintain their wide moat status, but at their current price aren't trading at much (if any) of a discount to their fair value estimate. The eight that got the boot in late June: Applied Materials (NASDAQ:AMAT), Microsoft, Intel, Compass Minerals International (NYSE:CMP), General Dynamics (NYSE:GD), John Wiley & Sons (JWA), St. Jude's Medical (NYSE:STJ) and Martin Marietta Materials (NYSE:MLM).

The eight wide-moat companies that are added to the index for the upcoming quarter had a price as of the June 21 rebalance that Morningstar deemed was at least 15% below its fair value. The eight additions: Amgen (NASDAQ:AMGN), Franklin Resources, eBay, Facebook, Maxim Integrated Products (MXM), Oracle, Qualcomm and Schlumberger (NYSE:SLB). Facebook, which Collins says benefits from a strong networking effect (the more people who use, the more people who want to use) has the biggest discount to fair value: 30% as of last Friday. Morningstar has a $35 fair value on Facebook shares, a level it hasn't touched since its May 2012 IPO.

FB Chart

FB data by YCharts

Western Union (NYSE:WU), an index holdover from last quarter, currently has the largest discount to Morningstar's fair value estimate -- at 32%. The most "expensive" stock in the wide moat index for the coming quarter is Berkshire Hathaway, which Morningstar says currently trades at a 12% discount to its fair value. By way of comparison, the average wide-moat stock currently trades at an average 5% discount, slightly better than the 4% discount for all Morningstar-rated stocks.

In its quarterly rebalancing, Morningstar also provided a neat watchlist: stocks 21-30 in their valuation of wide-moat stocks. These are the companies that just missed the cut for the 20-stock portfolio for this quarter, but could bubble up in the near future if either their fair value is adjusted (Morningstar tends to evaluate one a quarter) and/or the price slumps from here. Morningstar's self-described Next 10 potential holdings with their current Fair Value estimate are (including a few just booted): Medtronic (NYSE:MDT), $60, Baxter International (NYSE:BAX), $80, ITC Holdings (NYSE:ITC), $98, Coca-Cola (NYSE:KO), $45, Applied Materials ($17), Compass Minerals International, $94, Amazon.com, $300, Martin Marietta Materials, $119, St. Jude Medical, and John Wiley & Sons $45.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.

Source: Buffett-ish Market-Beating Fund - With New Picks