Pat Dorsey: Hi, I'm Pat Dorsey, director of equity research at Morningstar. At Morningstar's Equity Research Department, we're sometimes accused of taking a bit of an academic focus towards equity research. We spend a lot of time on competitive analysis and cash flow projections, but at the end of the day, the purpose is to pick stocks that go up.
So, the question is, did we do this? How has our performance been in 2009 and over the past few years? We recently published an article looking at our performance in '09 and in the past several years. I wanted to recap some of the highlights for you.
One of the first ways we can look at our performance in general is basically comparing how cheap we thought stocks were in aggregate to how the market has done. On that score, we've done OK.
In '07 and '08, we thought stocks were mildly overvalued. In hindsight, they were more overvalued then we had projected them to be, but at least we weren't pounding the table and saying, "Go out and put all your money into the equity markets."
What we did get right was calling the market as significantly undervalued in late '08 and early '09 when the median price-to-fair value of all the stocks that we cover reached as low as about 0.6, meaning that we thought the median stock in our coverage universe was about 40% undervalued in late '08 and early '09. Of course, that turned out to be a pretty good call.Read Full Transcript
We can also look at our valuation of popular indexes like the S&P 500 because, since we cover every stock in the S&P 500, we can basically take all of our fair values and roll them up into an aggregate value for the index. Well, before things really rolled over, we had a fair value of the S&P of about 1,500-1,600. That was certainly, in hindsight, too high.
We quickly adjusted that downward in late '08 to a level of about 1,200-1,250, and I'm very proud of the fact that we actually held our ground. Throughout most of '09, we held our fair value for the S&P at about 1, 200 even as the market was cratering down towards 800, 700 and down to the intra-day number of the beast low on March nine of 666.
We held our ground that whole time that the fair value for the S&P of 1,200. I'm fairly glad that we didn't succumb to the temptation to hide under the covers and not call anything a buy. In fact, we called quite a few things buys at that point in time.
Those are two big ways to look at the overall performance of our stock calls. Another way is basically have our 5-stars, our buy-rated stocks, outperformed our 1-stars, sell-rated stocks? One way we do this is sort of look at it by moat. Look at it by wide-moat, narrow-moat and no-moat stocks.
And here again, the story is pretty good. If you look at our wide-moat stocks over pretty much all time periods--trailing three years, five years and last year--our 5-star, buy-rated, wide-moat stocks have beaten our entire coverage universe of wide-moat stocks and, of course have done much better than our 1-star, sell-rated, wide-moat stocks.
Same story on the narrow-moat side. Of course, narrow-moat companies are the kinds of companies that don't have quite as strong an advantage as wide-moat businesses, and they are still good businesses. And those are businesses where, again, our 5-stars have out-performed narrow moats in general, as well as our sell-rated, 1-star, narrow-moat stocks.
Now, on the no-moat side of things, the story's a little bit more mixed, frankly. We cover about 900 no-moat stocks. These are typically sometimes smaller, less well competitively advantaged businesses. Businesses that we think are very prone to the vicissitudes of the economy and don't really have strong economic moats. And our performance here has been a bit more skewed, basically. We have not really done a very good job of sorting out the buy-rated ones from the 1-star, no-moat stocks. I think there's a couple reasons for this.
One is, well, frankly these are harder companies to value at the end of the day. They tend to be more volatile. They tend to be less predictable. They tend to be more easily buffeted by macroeconomic events, so they're just harder to value. They've also more volatile. They tend to be a little bit more levered and smaller, on average. They're just tougher companies to get you arms around. And our 1-star, no-moat stocks actually did incredibly well in 2009.
So, if you had owned this portfolio of beaten-down retailers, auto parts companies and media firms, you would have made a ton of money in 2009. You would have also needed a titanium-lined stomach to have held them from the beginning of the year through the March lows, and I'm not quite sure how many people would have had the fortitude to do this. If you did, more power to you. But I think the perhaps better risk-adjusted way is to think about the 5-star, narrow-moat and wide-moat stocks.
Finally, our strategies have done fairly well over time. These are kind of real money portfolios. Again, you're seeing more conservative strategies, like our Morningstar StockInvestor Tortoise Portfolio, didn't do quite as well in 2009, but it also didn't lose nearly as much money as the market in 2008, where as our more aggressive portfolios, like the Morningstar StockInvestor Hare, did quite well in 2009, as taking risk was rewarded by the market .
And our Wide Moat Focus Index, which basically takes the 20 cheapest of our wide-moat stocks, basically has been knocking the cover off the ball. It was up about 46% in 2009 and is beating the market by about 500 basis points annualized over the past five years. Again, it's a very simple, mechanical strategy. It's simply looking at our wide-moat universe of about 160 companies and looking for the 20 cheapest and then rebalancing quarterly.
I think what that really shows is the value of a disciplined approach and having a watch-list sorting out a group of companies you think that have the economic sticking power to be around for the long haul and waiting and buying them when they're cheap. That's essentially all this strategy does.
So, that's a pretty comprehensive look at our performance in 2009 and over the past several years. Overall, pretty good. We could have done a better job with the no-moat stocks but again, these are just frankly harder companies to get your arms around. They tend to be a little bit riskier and those were some missed opportunities, but overall, I'm pretty pleased with the performance.
I'm Pat Dorsey and thanks for watching.