• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Stock Screen>Moats around Small Castles

Related Content

  1. Videos
  2. Articles
  1. Stock ETFs Worth Sticking Around For

    Although the stock market isn't a screaming buy today, investors shouldn't completely abandon equities for bonds. Here are some stock ETFs that are worth a closer look.

  2. Session 2: Midyear Portfolio Checkup and Risk Factor Review

    Director of personal finance Christine Benz will help you check your true exposures and stress-test your holdings in session 2 of Morningstar's 2012 Midyear Financial Checkup.

  3. Session 3: Best Investment Ideas Roundtable

    A panel of Morningstar equity, mutual fund, and ETF experts detail several individual investment opportunities and sensible investing strategies for income and growth in today's tough market.

  4. When Less Risk Equals More Reward

    Recent research suggests that lower-volatility stocks and funds tend to perform better over the course of many years.

Moats around Small Castles

Use this screen to suss out small firms with economic moats and great valuations.

Haywood Kelly, 08/03/2009

When pondering companies with economic moats, the names that typically come to mind are the blue chips, from Microsoft MSFT and Procter & Gamble PG on down. But Morningstar analysts actually cover several hundred small-cap stocks that have distinctive competitive advantages of one sort or another.

All told, our analysts cover 900 small-cap stocks. Of those, 200 have Morningstar economic moat ratings of narrow or wide. Some names you or your clients might recognize include Blue Nile NILE (online seller of diamonds), Boston Beer SAM (maker of Samuel Adams), Clear Channel Outdoor Holdings CCO (billboard operator), Fair Isaac FIC (calculator of the ubiquitous FICO score), International Speedway ISCA (operator of Nascar race tracks), and Winnebago Industries WGO (maker of recreational vehicles). But I hazard to guess that most of the small-cap firms that Morningstar covers have probably never crossed your radar screen.

Yes, these companies tend to be riskier than the blue chips. And yes, small caps can get crushed in a deep recession like the one we're muddling through. But some of the firms that Morningstar covers in the small-cap area are truly great companies. Some have wonderful growth prospects; some are potential takeover candidates; and some will simply keep chugging along in their narrow, but profitable niches for decades to come. Given the sometimes dirt-cheap valuations of these companies, Morningstar analysts have consistently found attractive buying opportunities.

Equity Style Box = Small Cap

For this issue's screen, we first narrow in on companies with market caps below Morningstar's official cut-off between small- and mid-cap firms, which is currently $1.6 billion. What kind of universe does this produce? The average market cap of small-cap companies in Morningstar's U.S. equity database is $324 million (excluding pink-sheet stocks). The average daily trading volume is only about 430,000 shares, which contrasts with the 3-million-plus average for mid- caps. As we've written about extensively in these pages, low-liquidity stocks offer a blessing and a curse. The curse is that trading costs are high--large bid-ask spreads and a decent likelihood that a single order can move the price. The blessing, according to research from Roger Ibbotson and others, is that investors have tended to be paid handsomely for putting up with this illiquidity. (See "The Liquidity Premium" in the June/July issue.)

And Revenue TTM < = $2,000

We're putting a revenue screen here in order to focus on small companies. The small-cap universe consists of two types of firms: small companies and fallen angels (formerly large firms that collapsed in market value). While the latter category provides interesting investing opportunities at times, it's also not for the faint of heart, particularly in the midst of a once-in-a-generation financial crisis.

And Economic Moat not = None

blog comments powered by Disqus
Upcoming Events

©2014 Morningstar Advisor. All right reserved.