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Companies Where Management Teams Add Value

Use this screen to find strong stewards of shareholder capital.

David Krempa, 12/18/2012

This article originally appeared in the December/January 2013 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000.  

For this search, we will look for business trading at attractive valuations that also have exceptional management teams.

Stewardship = Exemplary

Morningstar recently launched new stewardship ratings to assess the quality of management teams. Morningstar’s analysts now rate the management of each firm they cover as Exemplary, Standard, or Poor. The rating seeks to analyze each management team’s stewardship of shareholder capital, with particular emphasis on capital allocation decisions. Analysts consider companies’ investment strategy, history of investment timing and valuation, dividend and share buyback policies, execution, among other factors. Firms that earn an Exemplary rating have a history of allocating capital to high-return investments with strong execution. Firms that earn a poor rating likely have a track record of overpaying for acquisitions or pursuing value-destructive investments. By limiting our search to only Exemplary firms, we eliminate more than 90% of Morningstar’s coverage universe.

And Morningstar Rating > 4 stars

Screening for 4- and 5-star-rated firms gives us companies that Morningstar’s equity analysts believe are trading below the business’ intrinsic value. Morningstar analysts use explicit forecast of firm’s fundamentals to arrive at a discounted cash flow valuation. Even the most well-run business could be a bad investment if the valuation is too high, so this criterion will make sure we are paying an attractive price for these well run businesses.

And 3 Year Revenue Growth > 5%

Next, we screen for stocks that have reported an average annual revenue growth rate of more than 5% over the past three years. Although recent results don’t provide a guarantee of what future results will look like, this screen should help us find businesses that have strong growth prospects. If nothing else, it will eliminate declining businesses. Declining businesses can be a strong investment at the right price, but with this screen, we are focusing on strong management teams that can create significant value for shareholders over a long time period, so growing businesses are much more likely to fit our bill.

David Krempa is an associate analyst with Morningstar.

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