Articles filed under "moats"
No one’s words – save, perhaps, Vladimir Putin’s – were parsed more closely over the weekend than Warren Buffett’s, as he issued his annual letter to Berkshire Hathaway (BRK.B) shareholders.
There were the usual shout-outs to Berkshire managers for doing a great job; a tutorial on how to think about investing that featured Buffett’s Nebraska farm and a commercial building near New York University; a mild mea culpa on some crummy bonds he bought without first asking Berkshire Vice Chairman Charlie Munger’s opinion; and praise for his equity managers, Todd Combs and Ted Weschler, each now running a $7 billion-plus portfolio, for beating the S&P 500 in 2013.
Oh, and this: Buffett gave such prominence to Berkshire’s investment in Bank of America (BAC) that it wouldn’t be surprising to see it become a permanent holding, and a big one. As you’ll recall, when BofA was really in the dumps in August 2011, Buffett engineered a deal to buy $5 billion in preferred shares. It was not unlike similar deals he struck earlier in the financial panic with Goldman Sachs (GS) and General Electric (GE), lending money at a high rate of interest but also lending his name at a time when the companies needed to calm markets.
With BofA, as with the others, Buffett drove a hard bargain. The BofA preferred, paying 6% annually, included warrants to buy 700 million BofA common shares at $7.14 apiece. So, in addition to the $300 million a year income Berkshire gets, the warrants are currently in the money by about $9.39 a share, or some $6.6 billion.
Investing in stocks deemed to have a deep competitive edge -- dubbed a wide moat -- seems to have its investing charms. As covered recently at YCharts the index that is the underpinning for the Market Vectors Wide Moat Index ETF (MOAT) has beat the overall market over the long-term.
The index is reconstituted quarterly to own the 20 stocks that Morningstar (MORN) has deemed to have wide moats and that trade at the most compelling valuations according to Morningstar’s proprietary fair value analysis. (Full disclosure: Morningstar is an investor in YCharts.)
Plugging this quarter’s portfolio into yet another value rating system, YCharts’ own, using the YCharts Watchlist function allows for some interesting slicing and dicing to get a more in-depth take on the relative value of each holding. YCharts’ proprietary Value Score assigns each stock a score between 1 and 10. During the highly volatile 2000-2010 stretch YCharts found that companies with the highest value score of 10 greatly outperformed those with the lowest value scores.
(You can learn more about YCharts Value Score here.)
Here’s what two years of strong market gains does to valuations: In January 2012 Morningstar’s index of the 20 most compelling stocks deemed to have wide competitive moats included 17 stocks trading at discounts of at least 25% to Morningstar’s estimate of fair value. At the latest quarterly reconstitution of the index just three of the 20 stocks in the index -- Weight Watchers International (WTW), Exelon (EXC), and Western Union (WU) -- trade at a discount to fair value of at least 25%.
(Full disclosure: Morningstar (MORN) is an investor in YCharts.)
That said, wide moat stocks aren’t any more expensive than the overall market. Morningstar pegs the price-to-fair value for all stocks it covers at 104% today, with the wide moaters on average coming in at 102%. While none of that screams bargain, at this juncture in the market the fact that you don’t have to pay up for companies deemed to have staying power is intriguing. These aren’t the sort of stocks that lead in uber bullish markets. The Market Vectors Wide Moat ETF (MOAT) ETF that tracks the index has slightly lagged the market over the past year:
If you’re a taxpayer (aren’t we all?) and felt a chilling wind blow through the pocket you keep your money clip in over the weekend, it might have been due to a decision by the federal government’s Centers for Medicare and Medicaid to go easy on the dialysis industry, enacting far smaller reimbursement cuts than previously expected.
The industry behemoths DaVita (DVA) and Fresenius (FMS) promptly rallied on the news. Their business, you see, is administering dialysis and collecting federal payments. In the U.S., that’s really about all there is to it, and it’s a booming industry due to our poor eating habits.
GMO, the $112 billion investment management firm led by chief investment strategist Jeremy Grantham is out with its latest quarterly letter (novella is more like it) and the news remains the same: stocks, in general, are not at all compelling. The firm forecasts a -1.3% inflation adjusted annual return for the S&P 500 over the next seven years.
Conservative, value-oriented investors? Of course. But ignore them at your own expense. You don’t manage $112 billion being wrong over full market cycles. And that’s the key: GMO is the rare firm that is focused on delivering through full market cycles, invariably by participating on the upside and outperforming on the downside.
Given the steep ascent of the market the past year, values are ever harder to come by. The 20 stocks in the Market Vectors Wide Moat Index ETF (MOAT) sell at an average 14% discount to Morningstar’s proprietary estimate of fair value. The ETF tracks the cheapest stocks in Morningstar’s Wide Moat Focus Index.
For big discounts among companies with competitive moats, you typically have to venture into turnaround/trouble territory: Weight Watchers (WTW) and Exelon (EXC) currently trade at less than 70% of Morningstar’s fair value estimate.
Weight Watchers revenue is down 4% over the trailing 12 months, and management says it expects more revenue erosion in 2014. Morningstar is currently maintaining its $50 per share fair value, but has said it will review its model once it gets a bit more guidance from Weight Watchers management. The new mightn't be so good. As YCharts' Dee Gill reported recently, weight loss apps hurt Weight Watchers.
Nuclear-utility powerhouse Exelon has been struggling amid weak energy prices. It’s been such a hard slog, Exelon slashed its dividend 41% earlier this year. Exelon’s deep discount is pegged to Morningstar’s expectation that natural gas prices and power prices should rise 30% as the market segues from early cycle to mid cycle pricing norms in the next few years. Given the sharp pick-up in U.S. natural gas production amid weak demand over the past five years, a 30% price rise could be a tall order.
One of the great things about incorporating employee data into your use of investment research tools is the ability to use the information to help spot companies with moats – the barriers to entry, or protective barriers, that limit direct competition, allow for pricing power and drive long-term and sustainable growth.
If you do a YCharts Stock Screener, using the S&P 500, and screen for market cap per employee, in the top 50 mostly what you get is not surprising: a bunch of asset-rich companies like REITs; extractive companies like oil and gas operators; a handful of pharmaceutical concerns that are smaller and thus less likely to hire on a huge sales force to roll out a drug; and tobacco companies. These have high market cap per employee because they don’t employ a lot of people.
For the past 18 months, Qualcomm (QCOM) stock has failed to join in the rally, lagging the market by more than 20 percentage points. Normally you’d have to have some sort of systemic problem (see: Intel’s (INTC) continuing quest to adjust to the mobile computing platform) to explain that sort of underperformance. But that’s clearly not the case with Qualcomm:
What’s worrying investors is that Qualcomm’s gravy train of royalty income from every mobile device using its patented 3G technology could take a hit if the average sale price of smartphones drifts lower, as is expected. (Qualcomm’s royalty is based on the average sale price of phones using its tech.) But what that notion seems to overlook is that if smartphone prices start to fall, then more folks will be buying smart phones. There’s no guarantee volume would offset any decline in per-phone flat fee, but the volume argument is pretty compelling.
BI Intelligence estimates that globally one in five cell phone owners has a smartphone, up from less than one in 20 just a few years ago. That’s a goldilocks situation: you’ve got evidence of the phenomenal growth rate, yet the penetration rate is still so low you’ve got plenty more room for more growth. Gartner estimates smartphone production will rise about 60% between 2013 and 2016.
Pharmaceuticals distributor AmerisourceBergen (ABC), with its massive moat, healthy share repurchases and big cash flow, has a good reputation as a long-term value investment. But these days, investors are turning to this $14.8 billion market cap company to fulfill another part of the diversified portfolio: growth.
AmerisourceBergen was one of 39 companies that popped up when we set the YCharts Stock Screener to find growing companies with features that reduce the risks typical of growth stocks. These “Sane Growth” stocks combine modest share prices and strong fundamentals with recent revenue and profit gains in double digits.
We further screened to define our Sane Growth Stocks and settled on five: Dollar General (DG), AmerisourceBergen, Clean Harbors (CLH), Eastman Chemical (EMN) and Wellcare Health Plans (WCG). We covered Dollar General in the initial article and will follow up with the others.
The latest fair value reading from Morningstar (MORN) among the stocks it puts through its proprietary analysis is signaling that values are hard to come by. The composite for those stocks shows prices are now 6% above Morningstar’s fair value estimates. The story is slightly better among the 200 or so companies that have carved out competitive advantages that Morningstar considers to be a “wide moat.” The wide moats recently traded on par with their estimated fair value.
Which isn’t saying much if you happen to prefer buying a stock at a sizable discount to its fair value. The promising Market Vectors Wide Moat ETF (MOAT) tracks Morningstar’s Wide Moat Focus index rebalances quarterly to hold the 20 wide moat stocks trading at the steepest discount to Morningstar’s fair value estimate. At the recent rebalance for the fourth quarter just six of the 20 stocks were trading at a discount of at least 15% to their fair value estimate. Not exactly a huge margin of safety.
Express Scripts (ESRX) is an intriguing outlier among the 20 stocks in the Market Vectors Wide Moat ETF this quarter. When Morningstar ran the rebalance in late September the leading pharmacy benefit management company traded at a 26% discount to Morningstar’s fair value. At a recent price of $62, the gap has widened to a 30% discount to Morningstar’s fair value estimate of $89 per share.
Normally there has to be some heavy storm clouds hovering over a company for it to trade at such a steep discount when the market in general is fairly valued. Indeed Western Union (WU) and Exelon (EXC) the two cheapest stocks in the Market Vectors ETF at the latest rebalance are not exactly firing on all cylinders.
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