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By Christine Benz and Laura Lallos | 02-11-2013 12:00 PM

Bargains Lacking for Dividend Funds

Recent Morningstar research shows that while some buys exist across the equity fund universe, many areas, such as dividend-paying stocks, are close to fully valued.

Christine Benz: Hi, I'm Christine Benz for Are U.S. equity funds a buy based on their underlying valuations? Joining me to discuss some recent research on that topic is Laura Lallos. She is a senior mutual fund analyst with Morningstar.

Laura, thank you so much for being here.

Laura Lallos: Thank you.

Benz: You recently took a look at the universe of funds that are in the Morningstar 500. Those are the funds we track in Morningstar FundInvestor. And the idea was to take the price/fair value ratios that our equity analysts assign to individual stocks and actually look at funds and attempt to figure out whether they are overvalued, undervalued, or fairly valued. So, let's start by talking about how our equity analysts arrive at those fair value statistics?

Lallos: Well, our equity analysts have their own proprietary discounted cash flow models to arrive at what they think is a fair value for the stocks they cover. And then based on that they can look at price/fair value ratios and determine whether a stock is fairly valued or a good buy today.

We noticed that looking at the median stock they cover, right now it's just about fully valued. And to put that in perspective, last June the median stock they covered was 85% of fair value. So we can see the recent stock rally reflected there.

Benz: Laura, in terms of the methodology, when you look at a whole mutual fund, how do you go about finding the price/fair value? Is it an average or weighted average? What are you doing there?

Lallos: We did an asset-weighted average, and we wanted to be sure that our calculation truly reflected the portfolio. So, we only looked at funds for which we had our equity analysts covering at least 75% of a particular fund's assets, so that we could say, yes, this is a reasonable reflection of the portfolio.

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