Why Moats Matter: The Morningstar Approach to Stock Investing

247 Pages·2014·3.64 MB·English

by  Heather Brilliant

Contents
Preface
Acknowledgments
Chapter 1: Guiding Principles of Morningstar’s Equity Research
Question 1: How Can We Identify Which Businesses Are Great?
Question 2: When Is the Best Time to Invest in Great Businesses?
Chapter 2: What Makes a Moat?
Moat Sources
Notes
Chapter 3: Why Moat Trends Matter
Moat Trends and Fundamental Performance
Five Key Considerations for Moat Trends
Intangibles
Cost Advantage
Switching Costs
Network Effect
Efficient Scale
Best Practices for Moat Trend Analysis
Chapter 4: How Stewardship Affects Economic Moats
Meet Our Stewardship Methodology
Drilling Down
Chapter 5: Applying Moats to Dividend Investing
Why Dividends Matter
Which Dividends?
Chapter 6: The Importance of Valuation
Valuation Concepts
Cost of Capital and Returns on Capital
Morningstar’s Valuation Approach
Example: Calculating ROIC
Forecasting Future Free Cash Flows
The Morningstar Rating™ for Stocks
Fair Value Uncertainty and Cost of Equity
Notes
Chapter 7: Do Moat Ratings Predict Stock Returns?
Chapter 8: Putting Moat and Valuation to Work: Portfolio Strategies
Wide Moat Focus Index
The Tortoise and Hare Portfolios
Chapter 9: Basic Materials
Commodity Manufacturers
Commodity Processors
Metals and Mining
Chapter 10: Consumer
Beverages
Consumer Products
Tobacco
Restaurants
Retail Defensive
Specialty Retail
Lodging
Notes
Chapter 11: Energy
Oil and Gas Drilling
Oil and Gas Exploration and Production
Oil and Gas Midstream
Refining
Oil and Gas Integrateds
Engineering Services
Chapter 12: Financial Services
Banks
Capital Markets
Credit Services
Financial Exchanges
Insurance
Chapter 13: Healthcare
Pharmaceuticals
Biotechnology
Medical Devices
Medical Instruments and Supplies
Diagnostics and Research
Chapter 14: Industrials
Railroads
Airport Operators
Aerospace and Defense
Trucking and Marine Shipping
Waste Management
Heavy Equipment
Diversified Industrials
Chapter 15: Technology
Consumer Technology
Enterprise Hardware Systems
IT Services
Semiconductors
Software
Telecom Services
Chapter 16: Utilities
Regulated and Diversified Utilities
Independent Power Producers
About the Authors
Index
End User License Agreement
List of Illustrations
Figure 1.1 Measuring a Moat by the Duration of Excess Returns
Figure 3.1 Moat Trends by Sector (%)
Figure 3.2 Independence of Economic Moat and Moat Trend Ratings
Figure 3.3 Top 10 Sponsors of Ongoing Clinical Trials of Antibody Drug
Conjugates
Figure 3.4 Procter & Gamble R&D Spending vs. Peers, 2003–2012 (as a
Percentage of Revenue)
Figure 3.5 FedEx Ground Market Share, 2002–2013
Figure 3.6 Majors’ Capital Expenditures vs. Production Levels, 2001–2012
Figure 3.7 Five-Year Total Cost of Ownership (%)
Figure 3.8 Growth in MercadoLibre’s User Base and MercadoPago Payment
Volumes (in Millions)
Figure 3.9 Nasdaq and NYSE Market Share, 2006–2013 (%)
Figure 3.10 Speed of Regulatory Approval and Probability of Success for
Orphan and Nonorphan Drugs
Figure 4.1 Stewardship Ratings by Economic Moat Rating (%)
Figure 4.2 Stewardship Ratings by Sector (%)
Figure 5.1 High-Yielding Stocks Outperform
Figure 5.2 Cumulative Price Appreciation (%)
Figure 5.3 Cumulative Dividend Return (%)
Figure 6.1 Market Fair Value
Figure 6.2 Graphical Illustration of Example Cash-Flow Profile
Figure 6.3 Graphical Illustration of Example RONIC and WACC Profile
Figure 6.4 Choosing an EBI Forecast in the Last Year of Stage 1
Figure 6.5 Scenario Analysis
Figure 6.6 The Morningstar Rating™ for Stocks
Figure 6.7 Uncertainty Rating
Figure 7.1 Cumulative Total Return of Moat Portfolios Rebalanced Monthly
to Equal Weights (%)
Figure 7.2 Cumulative Total Return of Volatility-Matched Moat Portfolios
Rebalanced Monthly to Equal Weights (%)
Figure 7.3 Rolling 90-Trading-Day Wide-None Premium (%)
Figure 7.4 Annualized Daily Future Returns (%) by Moat Rating and
Valuation Decile
Figure 8.1 Moat Upgrades and Downgrades as a Percentage of Our Total
Coverage Universe
Figure 9.1 Economic Moat Characteristics in the Basic Materials Sector
Figure 10.1 Economic Moat Characteristics of the Consumer Sector
Figure 11.1 Economic Moat Characteristics of the Energy Sector
Figure 12.1 Economic Moat Characteristics of the Financial Services Sector
Figure 13.1 Economic Moat Characteristics of the Healthcare Sector
Figure 14.1 Economic Moat Characteristics of the Industrials Sector
Figure 15.1 Economic Moat Characteristics of the Technology Sector
Figure 16.1 Economic Moat Characteristics of the Utilities Sector
List of Tables
Table 3.1 Median Metrics: Growth, Profitability, Valuation
Table 4.1 Stewardship Rating Distribution and Descriptions
Table 5.1 Clorox: Economic Moat Pays Dividends ($ Millions)
Table 5.2 Frequency and Magnitude of Dividend Cuts by Moat Rating
Table 6.1 Patterson’s Balance Sheet (Values in $ Millions)
Table 6.2 Patterson’s Invested Capital (Values in $ Millions)
Table 6.3 Patterson’s Income Statement (Values in $ Millions)
Table 6.4 Pros and Cons of Discounted Cash-Flow Analysis
Table 6.5 Valuation Uncertainty Rating
Table 7.1 Summary Statistics for Marginal Distributions of Future Monthly
Returns by Moat Rating
Table 7.2 Summary Statistics for Marginal Distributions of Future Monthly
Alpha by Moat Rating
Table 8.1 Annual Performance of Wide Moat Focus Index
Why Moats Matter
The Morningstar Approach to Stock Investing

Heather Brilliant
Elizabeth Collins
Jacket Design/Illustration: Christopher Cantore Copyright © 2014 by Morningstar, Inc. All rights reserved.
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Library of Congress Cataloging-in-Publication Data:
Brilliant, Heather.
Why moats matter : the Morningstar approach to stock investing / Heather Brilliant, Elizabeth Collins.
1 online resource.
Includes index.
Description based on print version record and CIP data provided by publisher; resource not viewed.
ISBN 978-1-118-76102-1 (pdf) — ISBN 978-1-118-76027-7 (epub) — ISBN 978-1-118-76023-9
(hardback) 1. Stocks. 2. Investment analysis. I. Collins, Elizabeth, 1979-II. Morningstar, Inc.
III. Title.
HG4661
332.63’22—dc23
2014017196
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