Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Matt Coffina--he's the editor of Morningstar StockInvestor newsletter. We're going to look at some recent changes to the Morningstar Wide Moat Focus Index and if investors can learn anything from it.
Matt, thanks for joining me.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: Could you give us a little bit of background about what this Wide Moat Focus Index is? What's in it?
Coffina: Sure. The Wide Moat Focus Index holds 20 wide-moat stocks that are trading at the cheapest discount to fair value in our coverage universe. Then, we rebalance it quarterly, and we equal-weight between these 20 stocks. Basically, it's a collection of high-quality companies trading below what we think their intrinsic value is.
Glaser: We did recently have a rebalance. What were some of the big changes? What came into the index?
Coffina: Turnover was unusually high this quarter. Thirteen different stocks exited and entered the index and, in all cases, the stocks that left the index exited because of valuation. In some cases, we cut our fair value estimates. In some cases, the stocks ran up. But in any case, we just take whatever the 20 cheapest stocks are, and sometimes that can cause high turnover. That was the case this quarter.
Glaser: When you look at what that bar was, how cheap does a stock have to be to be in that top 20?
Coffina: The stock would need to have a price/fair value ratio of 0.79, which is about as low as it's been in quite a number of years. Often, we have been picking between roughly fairly valued stocks until recently, but the market pullback in August and especially some sectors in particular that have pulled back much more sharply than others have finally created some decent discounts in the market. And that's reflected, I think, in this list.
Glaser: So, we're seeing some different valuations around sectors. Which ones are looking cheaper? What's overrepresented right now?
Coffina: So, the 13 stocks that were removed from the index were Amgen (AMGN), Varian Medical Systems (VAR), U.S. Bancorp (USB), American Express (AXP), Blackbaud (BLKB), Google (GOOGL), Harley-Davidson (HOG), VF Corp (VFC), Spectra Energy (SE), ONEOK (OKE), Exxon Mobil (XOM), Williams Companies (WMB), and Hershey (HSY). I think there are some common themes; probably the most notable one is that pretty much all of the energy stocks we had in the index came out. That's because we've continued to re-evaluate our take on energy, and we've continued to become more bearish on the long-run outlook for oil prices. We just recently cut our oil-price forecast to $70 a barrel for Brent and $64 for WTI. That's down $5 a barrel in both cases, and that was actually moved the fair value estimates of companies like ONEOK, Exxon Mobil, Williams, and Spectra enough that they fell out of the index.
Then, there was Blackbaud and Google--two software companies that did very well over the quarter. They actually contributed positively to our performance, and then they came out for valuation reasons.
The 13 stocks that were added to the index were Time Warner (TWX), Monsanto (MON), Emerson Electric (EMR), Union Pacific (UNP), Procter & Gamble (PG), Western Union (WU), United Technologies (UTX), CSX (CSX), Autodesk (ADSK), Applied Materials (AMAT), Norfolk Southern (NSC), Walt Disney (DIS), and Qualcomm (QCOM). I'd say the theme here is that we're really emphasizing some out-of-favor sectors. One in particular is railroads. Now there are three railroads in the index: CSX, Norfolk Southern, and Union Pacific. The other out-of-favor sector is media names; there are four different media names in the index: Time Warner and Disney, which were added this time, and then Twenty-First Century Fox (FOX) and Discovery Communications (DISCK) were already in the index prior to the rebalancing.
Again, I think these are two sectors that have been hit for different reasons, but they're very much out of favor right now--railroads because of declining coal volumes and concerns about the macroeconomic environment, and media because of concerns about cord-cutting, consumers abandoning the traditional cable bundle. But our analysts see value in both of these areas and in other areas that are out of favor right now.
Glaser: So, overall, there are some signs that the market is giving us some opportunities, even if there has been a bounceback from the correction we had.
Coffina: Yes. The correction didn't last long; it wasn't that severe. And when we look at the market's valuation overall, I'd say the market still looks roughly fairly valued. I certainly wouldn't call it a bargain by any means, but there are definitely some areas that have been hit a lot worse than others--down 30% or 40% in some cases. Often, in those cases, we think that investors have overreacted, and we finally have some real values.
Glaser: Matt, I appreciate your take on the index today.
Coffina: Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.