Step One: Wide-moat stocks with 5-star and 4-star ratings
Historical evidence says that while quality alone is a poor indicator of outperformance, when combined with a decent valuation filter, Morningstar’s moat rating proves to be more than useful. Based on the available data, stocks with a wide-moat rating that also fit into the 4- or 5-star category deserve to be the subject of further analysis. See the detailed explanation and the underlying evidence of our first step in this article.
We focus on those companies that are covered by a Morningstar analyst as assigning a wide-moat rating without thorough analysis is a questionable practice in our opinion. As of April 22, there were 184 wide-moat stocks meeting our criteria, up from 183 last month, as Sherwin-Williams (SHW) got included.
Only 8.2% (15 stocks) of this wide-moat group earned a 5-star (most attractive) valuation rating. Here are they:
Company Name |
Ticker |
Adobe Inc |
|
Equifax Inc |
|
Etsy Inc |
|
Meta Platforms Inc |
|
Polaris Inc |
|
Salesforce.com Inc |
|
Veeva Systems Inc Class A |
|
Yum China Holdings Inc |
|
Alibaba Group Holding Ltd |
|
Anheuser-Busch InBev SA/NV |
|
Imperial Brands PLC |
|
JD.com Inc |
|
Roche Holding AG |
|
Taiwan Semiconductor Manufacturing Co Ltd |
|
Tencent Holdings Ltd |
We believe that the percentage of 5-star-rated wide-moat stocks is a good indicator of market sentiment. When this percentage is high, even the best companies are on sale. When the percentage is extremely low, market conditions may warrant caution. (Please note that this is not an indicator for market timing!)
As these best of breed companies may be worth a closer look even when they are just slightly cheaper than their fair value but are not in the bargain bin, we also list the 4-star-rated wide-moat stocks as of April 22:
Company Name |
Ticker |
3M Co |
|
Alphabet Inc A |
|
Amazon.com Inc |
|
Applied Materials Inc |
|
Autodesk Inc |
|
Bank of America Corp |
|
Bank of New York Mellon Corp |
|
Biogen Inc |
|
Blackbaud Inc |
|
BlackRock Inc |
|
Boeing Co |
|
Brown-Forman Corp Class B |
|
Charles Schwab Corp |
|
Clorox Co |
|
Comcast Corp Class A |
|
Compass Minerals International |
|
Ecolab Inc |
|
Emerson Electric Co |
|
Gilead Sciences Inc |
|
Graco Inc |
|
Guidewire Software Inc |
|
Honeywell International Inc |
|
Intel Corp |
|
Intercontinental Exchange Inc |
|
International Flavors & Fragrances |
|
JPMorgan Chase & Co |
|
Kellogg Co |
|
KLA Corp |
|
Lam Research Corp |
|
MarketAxess Holdings Inc |
|
Masco Corp |
|
MercadoLibre Inc |
|
Microchip Technology Inc |
|
Microsoft Corp |
|
Moody’s Corporation |
|
ServiceNow Inc |
|
Starbucks Corp |
|
State Street Corporation |
|
T. Rowe Price Group Inc |
|
Teradyne Inc |
|
The Walt Disney Co |
|
TransUnion |
|
Tyler Technologies Inc |
|
U.S. Bancorp |
|
Wells Fargo & Co |
|
Zimmer Biomet Holdings Inc |
|
ABB Ltd |
|
Airbus SE |
|
Ambev SA |
|
ASML Holding NV |
|
Baidu Inc |
|
Bayer AG |
|
British American Tobacco PLC A |
|
Core Laboratories NV |
|
Experian PLC |
|
Fanuc Corp |
|
GlaxoSmithKline PLC |
|
Julius Baer Gruppe AG |
|
Medtronic PLC |
|
Unilever PLC |
All in all, we have 75 firms that pass our very first criteria. (Up from 68 a month ago.)
Step Two: Historical Valuation in the EVA Framework
We believe that the most widely used valuation multiples are terribly flawed. See this article on why we consider the Future Growth Reliance metric the best-of-breed sentiment indicator that addresses accounting distortions, thus gives us a true picture of which wide-moat companies seem attractively valued in historical terms. We want to buy our top-quality targets when the baked-in expectations are low, since that is when surprising on the upside has the highest probability. As investment is a game of probabilities, all we can do is stack the odds in our favor as much as possible.
38 of the 75 stocks survived this second step. Here’s the list:
Company Name |
Ticker |
3M Co |
|
Adobe Inc |
|
Alibaba Group Holding Ltd |
|
Alphabet Inc A |
|
Amazon.com Inc |
|
Applied Materials Inc |
|
Autodesk Inc |
|
Baidu Inc |
|
Blackbaud Inc |
|
BlackRock Inc |
|
Brown-Forman Corp Class B |
|
Comcast Corp Class A |
|
Equifax Inc |
|
Etsy Inc |
|
Experian PLC |
|
Fanuc Corp |
|
Imperial Brands PLC |
|
Intel Corp |
|
Intercontinental Exchange Inc |
|
Julius Baer Gruppe AG |
|
Kellogg Co |
|
Lam Research Corp |
|
MarketAxess Holdings Inc |
|
Masco Corp |
|
Medtronic PLC |
|
Meta Platforms Inc |
|
Microchip Technology Inc |
|
Polaris Inc |
|
T. Rowe Price Group Inc |
|
Salesforce.com Inc |
|
ServiceNow Inc |
|
Starbucks Corp |
|
Tencent Holdings Ltd |
|
Teradyne Inc |
|
TransUnion |
|
Unilever PLC |
|
Veeva Systems Inc Class A |
|
Yum China Holdings Inc |
We are rather strict when it comes to historical valuation. There are stocks that unquestionably fail both or short- and long-term tests. There are some targets, however, that may look attractively valued if you only focus on the short-term (like the last 5 years), but the longer you zoom out, the more you lose your appetite. It comes down to personal preference where you draw the line. For us, only those stocks are allowed to appear on the heat map in our third step that seem attractively valued in both a short-term and long-term context. (We go back as far as 20 years, calculate averages and medians on different time frames and let our algorithm do the ruthless work.)
Step Three: The Heat Map of the most investable wide-moat stocks
Seeing the stocks of our shortlist on a heat map with a quality and valuation axis is something that can prove very useful when we need to make a decision on which candidates to analyze thoroughly. As explained in our previous article, we use the PRVit (Performance-Risk-Valuation investment technology) model of the EVA Dimensions team.
All in all, PRVit is a multifactor quantitative stock selection model based on EVA-centric measures of Performance, Risk, and Valuation. It first estimates the fundamental value of a company based on its risk-adjusted EVA performance (shown on the vertical axis) and then compares it to its actual valuation (shown on the horizontal axis). All factors in this model were chosen heuristically based on common sense, and not by data mining, yet strong and statistically significant backtests prove the soundness of the PRVit approach both in the U.S. and globally. (See the details here.)
Here is the heat map as of April 22:
We also present the results in a table format to make your decision easier.
(Stocks highlighted in light blue are Morningstar’s 5-star-rated wide-moat names that survived the second step of our process.)
In PRVit, the factors are grouped into three categories: Performance, Risk, and Valuation. Each company has a composite 0-100 score in each category, where higher is better for Performance and lower is better for Risk and Valuation. We believe that stocks in the upper quintile of the PRVit ranking (with a PRVit score above 80) are worth a closer look.
We plan to run this three-step process on a monthly basis and publish the shortlist of targets it produces. If you don’t want to miss any of these pieces, please scroll up and click “Follow”.
Read More:Wide-Moat Stocks On Sale – The May 2022 Heat Map (NASDAQ:AMZN)
2022-04-25 18:33:00