Wide Moats, Good Stewardship Potent in Bear Market

During the brutal bear market of the past year, Morningstar analysts have noticed two interesting patterns among stocks they cover. First, the shares of wide-moat stocks (as tracked by Morningstar Indexes) have held up relatively well. Over the trailing one-year period, wide-moat stocks have shed 28.2% of their value, compared with a 49.4% drop for no-moat stocks.

                       Wide     Narrow     None
2008 Rtrn%   -28.2     -40.6       -49.4

As a reminder, wide-moat firms are those Morningstar's equity analysts think have the strongest competitive advantages. They're firms like Coca-Cola KO, eBAy EBAY, and Microsoft MSFT, which have the ability to earn outsized returns on capital for decades. Given their staying power, it's perhaps no surprise these companies have been held up better than most. The second pattern to emerge during the bear market is relatively good showing of companies with a demonstrated record of serving shareholders well. We see this clearly when breaking out performance by Morningstar's Stewardship Grades for Stocks. Firms with A Stewardship Grades--those with the most shareholder-friendly corporate practices--have posted the best returns. Perhaps companies that treat shareholders well were a little less likely to get caught up in the go-go lending policies of the past few years, or a little less likely to load up their companies with debt.

                           A            B          C           D           F
2008 Rtrn%   -28.25   -33.01   -39.14   -47.07   -35.57

It's important to emphasize that these two concepts--moats and stewardship--are entirely distinct. A moat or lack thereof characterizes a business, regardless of the quality of the managers and directors who run it. Morningstar covers many wide-moat companies that earn D's or F's for Stewardship, including AllianceBernstein AB, Amgen AMGN, Blackrock BLK, Federated Investors FII, and Hershey HSY. Likewise, many horrible businesses are run by capable, upstanding managers. But great management can't turn a poor business into a great one.

For this screen, we'll focus on companies that enjoy both a wide moat rating as well as an A Stewardship Grade. Even if economic conditions deteriorate, Morningstar still has confidence that these companies will live to fight another day. This screen works in Morningstar Advisor Workstation, but not Principia.

Economic Moat = Wide
Stewardship Grade = APAGEBREAK

About 30 stocks--out of more than 2,000 Morningstar analysts cover--pass this test. It's a pretty select group. To whittle the list down further, the screen will select only stocks that earn a Morningstar Rating for stocks of 5 stars. The star rating depends on our analysts' estimates of fair value for each stock. A rating of 5 stars means we think the stock trades at a significant discount to fair value.