Morningstar Classroom: Apple, Tesla, Amazon--Overvalued?

This event streamed Tuesday, May 25, 2021.

Dave Sekera: Welcome to the Morningstar Classroom. My name is Dave Sekera, and I'm the chief U.S. market strategist here at Morningstar Research Services. Joining me today is Karen Wallace, director of investor education for Morningstar. First, I'm going to start off walking you through Morningstar's equity research, valuation methodology, and then I'm going to talk to a couple of equity analysts about the stocks that they cover, and specifically take a look at one stock that we think is overvalued one that's undervalued, and one that's fairly valued and how they use that investment thesis within our methodology in order to derive their fair value, then I'll turn it over to Karen. Karen will walk you through some of the tools and screening capabilities on morningstar.com in order to help you surface new investment ideas. And then finally, I'll wrap up the presentation by talking about where we think the market valuation is today and help provide you some ideas as far as what we think is undervalued and overvalued in today's market. Dave Sekera: So first let me just provide a little bit of background about Morningstar. So Morningstar is one of the largest global independent providers of financial research and data, and we strive to be as transparent as possible with our products in order to be able to provide investors, everything that we think that they need to know to be able to make informed investor decisions and help empower them to make the best investments for their specific situations. And finally, we're not traders here at Morningstar. We believe in investing for the longterm. We find that the best investment outcomes are those investors that take actions investing for the longterm as opposed to trading. So taking a look at Morningstar's equity research group, we have over 120 analysts located globally, and those analysts cover over 1500 stocks across the world. Now all of that is covered by one overarching methodology. Dave Sekera: And so we're consistent in how we take a look at stocks, no matter where those stocks or those companies are located. Now, taking a look at our coverage. We do have stocks in each of these different areas. Again, we cover over 1500 companies and here in the United States, we cover about 700 companies domestically. But then when you include the ADR, is that trade for foreign stocks on us exchanges. We cover about 800 companies. We do cover the gamut from large cap, mid cap, small cap, and we do cover all of the main sectors. Now, again, part of our job here is to make sure that we don't get caught up in the short term market fluctuations, but really get past that and look into and delve into what we think the value of a stock is. So for example, there are multitude of different things that impact stock prices in the short term.

Dave Sekera:

So for example, just think about market sentiment overall, going into the late nineties, as we saw the technology bubble start, you know, building itself up before it burst, taking a look at, you know, the mid two thousands going into 2007 before the housing crisis and the global financial crisis. And again, markets, you know, popping from that bubble thereafter. And then most recently trying to really decipher what the long-term value of stocks were as we were going into the pandemic last year. So again, what's the longterm value of a company taking a look at those assumptions and those forecasts that drive the cash flows of those companies over the longterm, and then being able to provide an adequate rate of return and using our weighted average cost of capital in order to discount those cash flows to today, to be able to come up with our fair value estimates.

Dave Sekera:

So again, trading is not the same as investing traders are going to look to capture short-term profits on the movement of a security. Now there's a lot of different types of trading strategies out there. Most of them are probably based on specific momentum characteristics. They may include, you know, some catalyst analysis as well, but for the most part fundamentals really don't play that much of a factor in those trading strategies, investors, however, are really doing that bottoms up fundamental analysis on the company and its sector and coming up with those forecasts and those projections, as far as how much cashflow they think a company is going to be able to generate over the longterm and then coming up with the present value of that today, what we found for most investors that really it's the time that you're in the market that leads to invest our success, as opposed to trying to time the market.

Dave Sekera:

Now, in our valuation methodology, we do start off with this bottoms up fundamental analysis. We take that fundamental analysis and then each of those analysts will end up building a discounted cashflow model in order to drive what they believe the fair value of that company is going to be really looking at the intrinsic value of the company in and of itself. We then use that in order to come up with the individual stock price on that company that we think is fair value. And then on top of that, we have an uncertainty rating that uncertainty rating is then used as an overlay to be able to drive how much margin of safety we would recommend investors should have from that fair value before they can start buying that stock into their portfolios. And that's what then finally drives the morning star rating for stocks. This is a scale one through five stars.

Dave Sekera:

So one star stock is one of those stocks that we believe is probably the most overvalued and five star stocks are going to be those stocks that we think are significantly undervalued. So with that, let's talk to a couple of different individual equity analysts and let's learn from them, how do they use this valuation methodology, transform that into their investment thesis, and then take that investment thesis to be able to develop the fair value estimate on those stocks that they cover. So first let's take a look at a stock that we think is undervalued in today's marketplace. So with me is

equity analyst in our technology team to talk about Amazon. So Dan, could you just provide us a quick overview of what your investment thesis is on Amazon?

Dan Romanoff:

Sure. Thanks Dave. And no problem. Uh, so for Amazon, we see several secular themes coming into play here. The first is e-commerce, uh, we think that, uh, e-commerce really is still in the early innings of adoption by consumer. And I think the pandemic sort of accelerated that. So you see new categories coming online for the first time that consumers maybe were uncomfortable with before and now they're buying groceries online and they're buying pharmacy products online, you know, furniture apparel, a couple of other categories too, that are sort of new, newer to e-commerce. So I think that is just part of a secular trend. I think demand has been pulled forward by a couple of years in a transition to a more of an e-commerce world. You know, it's kind of a strange to hear that only 14% of retail revenues are done in an e-commerce manner.

Dan Romanoff:

And I just, I think that is indicative of, uh, how early on we are in this process still in Amazon, in, in that 14%, Amazon has 42% market share of that and that keeps growing every year. So I see a more legs to that story. So from an e-commerce perspective, that is impressive. Uh, and then Amazon prime sort of helps consume, you know, it helps grease the wheels a little bit and helps it make it more comfortable for consumers to spend more money on Amazon. That is they get some benefits that, you know, non-prime members do not get. So you get access to movies and other kinds 10, um, and, and prime members tend to, and more, uh, they tend to buy more categories. They tend to shop more frequently on Amazon. So, uh, that's sort of a nice virtuous circle that's created there. Um, and then, um, so that's the e-commerce part and then sort of from the public cloud part, you have, uh, Amazon web services, AWS.

Dan Romanoff:

Uh, we think this is in the early innings here. Um, you had $45 billion in revenue last year, uh, from AWS and that is growing very rapidly, you know, well, above the corporate average, uh, this is the highest margin segment that they are reporting separately. Um, and I think, you know, we're in the early innings, you have strong growth ahead of you for years to come, and they are the clear leader in this, in this category. So I think, uh, that's going to help drive growth and profitability for years to come. And then lastly, uh, we have the other business which is advertising, uh, mainly advertising. And this is a business that is also, uh, significantly, uh, outgrowing the rest of Amazon and has much higher margins as well. And if you think about it, what you have is, um, shoppers who are looking for a specific product sort of immediately, and as they're doing their product searches, um, you know, this is very valuable to advertisers and probably more valuable than say something on one of your internet browsers or, uh, you know, search engines or what have you. So, uh, so I think that's very attractive advertisers and you get higher margins on this business. So, so generally speaking, this should help propel growth and margin expansion, uh, over the long-term for Amazon. So that's kinda the way we look at a company.

Dave Sekera:

So as an analyst, can you just walk us through, how do you take Morningstar's equity, valuation methodology, blend that with, you know, your investment thesis on the stock and be able to drive what you think the fair value of that company is?

Dan Romanoff:

Uh, sure. So, so we have a wide moat rating on Amazon, which sort of allows us to look at the company over a longer time frame. Uh, we, we have a ten-year explicit DCF, uh, forecast, uh, we model the growth, the revenue growth by segment. Uh, so some of those, some of those categories, we were just talking about e-commerce, um, AWS, other, which is mainly advertising again, we modeled those out separately, um, you know, from a long-term basis. Uh, so we, you know, we factor in our assumptions there, we have approximately 11% compound annual growth rate of around 11% over the next 10 years, uh, all in, um, we see revenue growth slowing from loosely 25%, you know, down to, uh, somewhere near 10% in 10 years. Uh, that says kind of the way we're looking at the company overall, obviously the segments, uh, differ a little bit in their growth profiles, uh, and we model out our expansion, our expectations for margin expansion.

Dan Romanoff:

Um, you know, when we sort of go through the same methodology, they're looking at it by segments, thinking about what they'll be investing in, um, what their needs are in terms of cap ex and anything they may be building out in terms of programs. Like, uh, most recently they've been building out, um, their, uh, transportation network for like next day delivery. So, uh, so that's an investment area. Um, so you know, AWS, so again, AWS and the advertising sort of the fastest growth areas, those have significantly higher margins, sort of 30% plus margins operating margins versus the rest of Amazon. Uh, so that's gonna uplift margins for the entire company in our view. So that's kinda how we think about it financially over, uh, say the longterm

Dave Sekera:

Now, based on that fair value estimate, you know, we currently rate the stock as a four-star stock, meaning that we think that it's undervalued in today's marketplace. What do you think the market is missing on this one?

Dan Romanoff:

Um, so as, so, as I look at Amazon just on a financial basis, I see a couple of things as I compare it to say visible alpha consensus. I see we have a little bit higher growth expectations, a little bit higher margin expectations, uh, over say the medium term, say five years. So that's, that's, uh, definitely a factor there. And I think probably, uh, realistically, um, AWS and the advertising businesses are probably areas where we differentiate ourselves and we're probably, um, more bullish I would say than, uh, other investors.

Dave Sekera:

Great. Well, thank you very much, Dan. We really appreciate your time and sharing your insights with us today. Thank you. Next, let's take a look at a stock that we consider to be fairly valued. Joining me as

, who is an equity strategist on our technology team and Morningstar's equity research group to talk about apple. Now, a lot of people might find it interesting that assign apple a narrow economic moat. I think most investors might consider that they would think that apple should have a wide economic moat. Abhinav could you give us a quick synopsis as far as why we assign the company only a narrow moat as opposed to a wide moat?

Abhinav Davuluri:

Certainly. So Apple's narrow economic moat stems from its switching costs, as well as intangible assets. Specifically, the switching costs around it's walled garden for its iOS devices, namely the iPhone iPad and Mac, as well as intangible assets around its iOS operating system, as well as the experience that users get that it's, uh, not replicable, uh, and, and other, uh, operating systems, for example, such as Android. So apple has developed this very strong, I think, stickiness that makes it very difficult for users to switch away from those devices. And as such, we see a pretty comfortable 10 year horizon for excess returns. What prevents us from assigning a wider economic moat is primarily the fact that we do not have the confidence, uh, in consumer hardware stickiness for a 20 year horizon, given the short duration of the product cycles of Apple's devices, namely the iPhone that could be anywhere from three to four years or even less. In some cases, we think that there is too much risk of disruption to Apple's dominance in the smartphone hardware market. Similar to what we've seen in the past would say a Nokia or a Blackberry. Now,

Dave Sekera:

When I'm thinking about the apple valuation, and we start incorporating that narrow economic moat into your investment thesis, could you just provide us an overview of your valuation and maybe some of the main drivers that, that, that gets to how we value that stock?

Abhinav Davuluri:

Certainly. So our fair value estimate is $115 per share derived from a DCF valuation that explosively for, um, models five years out into the future. And the main revenue drivers are certainly the iPhone and in 2021, the new 5g iPhone 12 will be leading to significant double digit growth in that subsegment. The firm has also been experiencing really solid growth in the services and wearables sub segments. And our expectation is that the iPhone will return to a more normalized sort of low to mid single digit level growth after this initial Supercycle 5g iPhone. And then the other smaller subsegments such as services and wearables will continue to drive a stronger, lower double digit growth rate on average culminating in an average revenue growth rate of in the mid single digits, uh, from, from a mid cycle standpoint on the margin front, we see margins, especially on the growth side remaining in kind of the high 30% range, whereas operating margins will also kind of plateau and kind of the high 20% range and longer term.

Abhinav Davuluri:

We think that there's going to be multiple puts and takes with respect to margins, such as, uh, potential higher margins from a higher mix of services and software, but also potentially lower margins from, uh, pressure on, on kind of the hardware side and more expensive components as apple tries to continue dominating the, uh, the smartphone market with new features. Uh, but all in that kind of culminates in, in a relatively stable margin profile. And from an earnings perspective, we think that the firm will be able to generate kind of a slightly higher growth than it's mid single digit revenue growth, uh, at about kind of the high single digit, maybe low double digit earnings growth on average, uh, in our explicit five-year forecast.

Dave Sekera:

Now looking at apple stock, it has fallen a little bit off of its recent highs and as it's fallen, it's actually moved into that three-star category from a two-star category. So I'm curious, are there any specific areas in apple that you think are different in how you look at the company versus how the market looks at the company and what are you watching for some of those areas going forward? Yeah, there's two areas that I think

Abhinav Davuluri:

We differ somewhat from the market. I think overall, overall, our thesis is quite comparable, but perhaps on the iPhone front, the recent straw strengthen and kind of Supercycle of the 5g iPhone 12, we think that may slow down a little bit sooner than what the market and maybe some of our other, uh, analysts peers are kind of contemplating. And then secondly, but maybe more importantly from a longterm perspective on the services front, apple has generated a ton of revenue growth in recent years, particularly from the feed that it captures in the app store. And we think that could be an area that begins to come under some regulatory pressure that could lead to some slower revenue growth longer term. But for now, you know, the firm is executing really well. They've benefited a lot from the kind of pandemic situation that led to a lot more demand for iPads and backs with everyone working and learning from home and as such the near term, we think will, will still quite be strong.

Dave Sekera:

Abhinav thank you very much for your time this afternoon and providing your insights on apple stock for us. Thank you. Next let's turn to a stock that we consider to be overvalued in today's marketplace. Probably none is more hotly contested than Tesla. Joining me is

equity strategist covering us autos for Morningstar's equity research group. Tesla hit its highs earlier this year, but the stock has retreated since then. And it's now at the point where we currently rate the stock with two stars. David, could you just provide us a quick overview as far as why you think that stock is overvalued in today's marketplace?

David Whiston:

Well, there's, there's really, uh, obviously a lot of controversy around Tesla and it's, it's really, to me the ultimate story stock as to meaning it's not really important. How many vehicles does it deliver this quarter? For example, what really matters is what is this company going to look like in 2030 and 2040? Um, and, and there's a lot of debate around that. You first, you've got COE, Elon Musk saying that, uh, no later than 2030, they'll sell 20 million vehicles a year while I'm model 28.4 million vehicles delivered cumulatively, uh, between 2021 and 2030. Now, if you believe mosque, then the SOC is actually undervalued as our fair value estimate at 20 million annual units a few years from now, it would be roughly in the area of $1,500 a share, but you have to assume utter domination by Tesla to do that. 20 million is roughly twice the size today of Toyota and all the VW group.

David Whiston:

So given how much good Bev or BV or all electric competition is finally coming Tesla's way, I'm not ready to give them the benefit of the doubt on 20 million units a year. Now that said, I do model over 50% annual unit growth for each of 2021 to 2023. So in that vein I'm in line with Tulsa's guidance of at least 50% annual unit growth over a multi-year R horizon, but I model growth slowing a lot sooner than Tesla talks about because of the competition looming. I have a revenue caker for 2030 versus 2020 revenue of about 24%. So what is all that other competition? Well, it's, it's a lot. And unlike in the past where you just saw automakers, come out with these ugly Ikano boxes that can do say 110 miles of range. Um, now you've got some really formidable competition coming. Let's start with GM, they've got 30 beds by 2025 coming, making up at least 1 million units annually by then, you've already seen the Cadillac Lira crossover get on unveil, the GMC Hummer pickup and the GMC SUV, uh, Babs with their crab lock feature.

David Whiston:

And that's just the beginning. You, they have to bolt models as well. Um, so crossing my fingers for a Bev Corvette someday, and very soon, we'll see the, the Bev, uh, Silverado is coming for. It's already got the Mustang Maki, which I think is a solid, although not perfect competitor, the Tesla model, Y Ford's also unveiling their Bev. F-150 this week called the lightning and the F150. Remember that's a top selling vehicle in America. So Ford is making bad Bev and GM's making an all electric full-size pickup that shows Detroit does not think EVs are a fad. Let's go over to Europe, Daimler's Mercedes and the EQs sedan. It wasn't shown this year, but EQs interior is just to me, absolutely gorgeous and luxurious. And then interior is something I've been critical on Tesla for a long time, because I just don't think they're up to par for what Tesla charges.

David Whiston:

Um, if you don't believe me, go to an auto show is sitting at a seven series or an S-Class or whatever. It may be an Audi eight, take a look, and then sit in a model. S I just don't think there are that the Tesla's on par and with the EQs for Mercedes. It has a lot of things that Tesla fans like to talk about. Both are futuristic. Both are like a spaceship, both look amazing. Um, oh, I think, or at least cool, but I think the Mercedes looks amazing. Press the Tesla just looks futuristic. I think the Mercedes is the better choice on the interior BMW. They're looking to do a target of at least 50% of their global unit volume be full electric by 2030 and 12 beds by 2025 VW group, which is coincidentally a big fan of Tesla. They're looking for 25% of their volume to be built by 2025.

David Whiston:

And Porsche alone wants about half their volume to be either plug-in hybrid or full electric. Honda's using GM's ultimate Altium battery technology for two beds that GM will then make for them in the north for the north America market, or I think believe in the 2024 model year. And Honda's new CEO just said in April, he wants 40% of Honda's 20, 30 volume to be zero emission globally Toyota this year, uh, they're still really focused on their hybrid expertise, but they've also said Alexis will sell more hybrid and electrified vehicles and combustion by 2025. Um, and in the U S Bevin fuel cell electric will be 15% of Toyota's, uh, 2030 us volume. And globally Toyota is looking to do 8 million electrified by 2030 with 2 million of that alone being Bev and fuel cell. So there's a lot of competition coming here now on margins. Um, you can draft argue. I'm not giving Tesla enough credit, and I think that's debatable, but over my 10 year forecast period, explicit forecast period, I've got EBIT margins, including SOC option comp expense, mostly in the low teens with a 13% mid-cycle EBIT margin. And for perspective, to justify the current stock price at roughly $575, holding all else, constant ID to mid cycle operating margin of about 24%, which I think is very generous without some help from non traditional automaker businesses.

Dave Sekera:

Now, in addition to your views on the electric vehicles, you know, Tesla does have several other business lines as well. Could you provide an overview of how you include that in how you look at those as part of your equity valuation?

David Whiston:

Sure. So a lot of different, uh, irons in the fire, so to speak some of which I'm, I'm modeling, giving them credit for, and some I'm not yet when I'm not modeling it specifically as insurance. I just think it's too early to see where that goes. Um, and honestly, I just don't feel Tesla's market cap is where it is today because of them doing insurance, the energy business. I bet I do model it's 7% of our fair value estimate. Now some may argue that's too low, but I've been very generous on the growth on that segment, modeling its revenue, going from about 2 billion in 2020 to 27 and a half billion dollars in 2030. Now, AVS are autonomous vehicles and robo taxis. That's a very nebulous one because it's a market that doesn't yet exist. I've long had the opinion that robot taxis are a race to the bottom on pricing because long-term Tessa, won't be the only ones doing this.

David Whiston:

There's Waymo, there's GM's cruise, which I think is very under appreciated. Uh, Toyota's my opinion, probably doing a lot more on abs and they're discussing publicly, um, Ford and Volkswagen jointly own Argo, which, and they've been testing, uh, that business in many studies for a long time. Now, such as Miami Daimler has been doing this for years too, and there's plenty of others such as startups. So I think, um, I just, I don't want to assume Tesla achieving world domination on AVS and robotaxis. Um, but I do model it, I assume in 2030 that Tesla has 10% market share of autonomous vehicle miles sold and it's charging 25 cents a mile, which translates into only about 4% of the fair value estimate. So what I'm skeptical skeptical about with Tesla on AVS is, is really two things. Number one, do they really have full autonomy or what we call level five and two will too many people overstretched financially to buy a Tesla thinking they'll make a lot of money putting it into the, into Tesla's AB ride hailing fleet, and then find out, uh, as I showed in a 2018 report that demand for miles driven is not uniform throughout the day.

David Whiston:

It's more of a barbell in terms of peak times being 7:00 AM and three to 5:00 PM or 3:00 PM being the peak time in the United States. So what could happen there is somebody who thinks they'll make a lot of money leasing their car into the Tesla fleet may actually get turned away and then not make that much money. And then they've, they've got a problem because now they've perhaps got a vehicle that they can't afford, or they're just not making as much as they thought they could when they bought the vehicle

Dave Sekera:

Know. And in addition, I was reading your research and we do rape hustle, and I believe we awarded the company a narrow economic moat last fall. So I'm curious, could you just provide us a synopsis? You know, what is the basis of that economic moat?

David Whiston:

So the moat that we were in last October, that's two of the five moat sources in remote framework that being a cost advantage and a tangible asset, the tangible asset in this case is around Tesla's brand and brand equity. Uh, I'll talk about costs first. So really starting from scratch as a startup that has enabled Tesla, I think to build bevs, uh, from the ground up and create processes that legacy automakers may find may find hard to match. Um, Tesla talked to their battery day last fall by reducing costs by 56% battery cell costs, uh, specifically. And that's basically a lot of massive by massively vertically integrating themselves and, and introducing some new technology, uh, like the new cell technology they're talking about, uh, 46, 80, um, other auto makers may not ever catch Tesla in terms of cost or range, but it's possible, especially longterm.

David Whiston:

That gap really may not matter that much. Um, just like today, there's tons of Android phones and iPhone smartphones and windows PCs versus Mac computers. Um, w you know, apple, for example, may, may be the more technically superior product, but the other competitors still do a lot of volume. So there really could be room for both the thrive here and that that still means Tesla could do well, but it doesn't necessarily mean Tufts is going to sell 20 million units a year. Time will tell. Now, the second source, as I mentioned, is, is the brand equity. I do expect Tesla to keep innovating, to remain competitive, if not always a leader in attributes, such as battery constant range. And I think as long as Elan's there, that certainly helps the brand. Um, I think they were very smart to start at a premium price point and then have a celebrity CEO, and that what that's done is it creates massive free advertising.

David Whiston:

It's also created a halo effect that benefits future Tesla vehicles after the model S came out such as the model three, the model Y and even in my opinion, that hideous. So avant garde looking cyber truck that will go on sale soon, but Tesla's brand, this is part of the ironic appeal. I guess Tesla's brand makes that ugly cyber truck appealing to some people. And I think the cyber truck is actually going to do pretty well, at least in circuit, certain circles, especially among the very wealthy consumers. There's also the supercharger network that has, I think, helped the brand to as a combat range anxiety. And it's helped them, uh, continue to grow and get some people to make that initial switch from ice over or combustion over to pure electric. I think Tesla was smart to do the supercharger as a pioneer long-term though. Um, it may not be needed. Um, but at the end of the day, that that would just probably mean some non-cash write-offs and, and you move on. So, uh, Tesla does have an error mode, but it can still be an overvalued stock.

Dave Sekera:

Well, thank you, David. I appreciate your time this afternoon. Sure. Next, let me turn over to

director of investor education, and she will walk through some of the tools and some of the screening options that we have available on morningstar.com for investors to be able to look for new investment ideas.

Karen Wallace:

Hi, I'm Karen Wallace, and I'm going to show you how to use Morningstar tools and ratings to find some great investment ideas and build a watch list. I want to start with this quote from Warren buffet, as Buffett explains a key element, arguably, the most important element of determining a stock's valuation is identifying whether a company has some sort of competitive advantage in place to insulate its profits and protect them from competition. As David explained, Morningstar analysts value stocks by determining the present value of long-term future cash flows. A key factor in that evaluation is identifying whether a company has any sustainable competitive advantages that would protect its profits. We award a wide economic moat to firms that we believe can fend off competition and earn high returns on capital for more than 20 years, only 15% of our coverage is currently rated wide moat. We award a narrow moat to companies whose competitive advantages should last at least 10 years a company with either no advantage or one that will quickly dissipate as no moat.

Karen Wallace:

Specifically Morningstar equity analysts are looking for companies where the return on invested capital exceeds the weighted average cost of capital. Let's go through some examples of different moat sources. First network effects. We think Facebook has a wide moat based on network effects around its massive user base and its vast collection of data that users have shared on various sites and apps. WhatsApp, Instagram messenger Facebook has really been able to effectively monetize that network through advertising, and we think it'll be able to continue to do so trucking and transportation services provider Landstar systems has a vast network of shippers, sort of a physical network, um, truckload carriers, independent sales agents, any attempts to duplicate this network by small providers with fewer resources, would it be impossible, but it would be very difficult. And finally, Dan Romanoff touched on earlier. We think that Amazon's retail business has a wide moat stemming from its huge marketplace, more buyers and sellers attract more buyers and sellers.

Karen Wallace:

And it also has some intangible assets associated with technology and branding. Um, the common thread that weaves through the retail business is Amazon prime, which you pay $120 a year. And it allows users to have expedited shipping on many items, access to prime video prime music, a variety of other benefits. Moving on to intangible assets. Apple has both hardware and software design expertise, which has allowed it to build superior products that integrate together seamlessly. The crown jewel is the iPhone, but there's also the iPad, apple TV, apple watch, air pods and so on. And they're all running on Apple's iOS operating system. There's also services mess. iMessage, uh, FaceTime, apple pay that strengthen Apple's hold on the consumer and keep them in apple sort of walled garden. So to speak Tesla as Dave Whiston discussed earlier, we expect demand for battery electric vehicles to continue to grow as other automakers move into the space.

Karen Wallace:

We expect Tesla to keep innovating, to stay ahead of startups and established competitors. Tesla's early mover advantage in electric vehicles has allowed it to build factories and vehicles from scratch and create processes. That legacy automakers will likely find hard to match. Especially as legacy automakers are saddled with the costs of producing internal combustion engines. Let's talk about cost advantage. Coca Cola sells sugar water, but because of its strong brand and consumer loyalty, it enjoys leading volume and most of its markets. But one thing we really like about Coke is that it's positioned itself in an area of the beverage supply chain. That's structurally lower cost. Most kooks that consumers buy are not packaged and distributed by the company itself. Instead Coke focuses on producing the concentrate or syrup for these beverages and ships it to bottlers for processing, packaging and distribution. All of which are capital intensive and costly operations, Novo Nordisk, a Danish pharmaceutical company that makes diabetes therapies.

Karen Wallace:

Novo's human insulin patents have actually expired. A generic insulin is available on a limited basis, but entering the insulin market requires significant upfront costs. There's high costs for clinical trials and there's high costs associated with manufacturing, efficient manufacturing and economies of scale. Combined with huge global Salesforce has allowed Novo's insulin business to remain profitable. It's remained more than 90% of the insulin market, even though generic insulin is available. Efficient scale Magellan midstream partners is a master limited partnership that operates pipelines and storage terminals in central and Eastern United States. It earns a fee-based stream of cash flows from transporting, storing and distributing refined petroleum products and crude. It has the country's longest petroleum pipeline network, which would not be easy or cheap for a competitor to build ups. Similar story. If a new competitor were to come on the global shipping scene, hoping to compete with ups, it would need to replicate UPS's sprawling network of planes, trucks, sorting facilities and skilled employees.

Karen Wallace:

A new entrant would face massive investment and likely years of losses before it could win critical volume of customers and become profitable. If it ever is. We'll talk about switching costs. Enterprise software solutions tend to be sticky because they keep everything running. And it's a big project to replace a multi-process integrated system that keeps things operating Workday. This is cloud only human capital management software that companies use to run their HR operations. Switching costs come into play here mainly because of the direct time and expense of switching to a new software package. And there can also be some loss productivity as people learn how to use a new system, but perhaps most important there's a risk that you could lose data during the changeover and employee data has a lot of personal information. Compensation records, the risk of corruption or a data leak during a transition would be direct disastrous.

Karen Wallace:

And Workday has a renewal rate close to 100%. We think Microsoft's different segments and products benefit from different moot sources, but Microsoft office has high switching costs and network effects. The programs are widely used. They function well and users are familiar with them. There's also a network effect. A large base of office users has led software developers to create products specifically for Microsoft office. Let's turn to the screening tool to look for some alternatives to Tesla or ways to play the electric vehicle trend at a more attractive price. Nissan's early move into mass market electric vehicle technology could provide a temporary competitive advantage. Nissan is part of a strategic Alliance with Renault and Mitsubishi and the company's co-investment in all electric vehicle capacity helps reduce Nissan's risk relative to attempting to launch on its own. Also most automakers are not as far along with their investment in EV technology and don't have as much experience since 2009.

Karen Wallace:

The Alliance group has produced and sold more than 700,000 battery electric vehicles. BMW continues to outperform the overall car market despite the global economic uncertainties from the coronavirus. And it's one of only a handful of automakers to which we assign an economic moat. The company had previously stated that it expected 20% of sales volume to be battery electric vehicles or plug-in hybrid electric vehicles by 2023 BMW now expect sales of battery electric vehicle units to annually grow by 50% through 2025 by 2025, the company believes it'll have delivered a cumulative 2 million battery electric vehicles in the early 2030s. Many will become a battery electric only brand. If you're not averse to moving up the supply chain a bit, there are also auto parts suppliers that stand to benefit from increased demand for electric vehicles. Our analysts believes four-star neuro remote rated bore Warner is well positioned for growth in hybrids and battery electric vehicles during an investor day presentation a few months ago, BorgWarner management estimated that revenue from electric vehicle products will grow from less than 3% of revenue currently to more than 25% in 2025 and more than 45% by 2030 turning to some alternatives to apple apple.

Karen Wallace:

We actually classify apple as a consumer electronics company, but if you're looking for some plays on tech, we have some really interesting plays that played to the switching costs moat. Splunk software helps companies index vast quantities of data, which helps them maintain and monitor mission critical functions in a variety of cases within security, it operations and observability via forwarders Splunk extracts data from different business sources, indexes the data and then allows users to query the data using proprietary schema on the fly offering to generate results in the form of reports, charts, and dashboards. We think Splunk's wide array of products that employ machine learning capabilities to support essential operations benefit from high customer switching costs and network effects, uh, supported by strong user metrics. In our opinion, this will drive excess returns over the next 10 years. Checkpoint software technologies is a top 10 player in the cybersecurity market.

Karen Wallace:

It generates revenue from selling products, licenses, and subscriptions to protect networks, cloud environments and points and mobile users checkpoint has morphed from its roots as a firewall pioneer into an enterprise wide security provider. We assigned checkpoint a narrow economic moat rating. In our view, checkpoint has developed considerable switching costs that inhibit customers from changing cyber security solution providers, advanced micro devices, designs, and array of chips for various computing applications. These products include central processing units and graphics processing units tailored to PCs game consoles and servers AMD upgrades in the x86 based duopoly with Intel that dominates the PC and server CPU markets. We think AMD benefits from intangible assets related to its x86 instruction, set architecture, license, and chip design expertise, which gives us confidence that the firm will generate excess returns over the cost of capital over the next decade and warrants and narrow economic moat rating. And now we'll turn it back to Dave and he can show you where he's finding value in the market. Overall,

Dave Sekera:

Thank you, Karen. So let's take some of those screens and some of those tools on morningstar.com and let's look at how we can apply those in order to find new investment ideas based on our view of the equity markets today. So at the end of the first quarter, we used an aggregate of all of those stocks that we cover and use those fair values to determine that we thought the market was broadly speaking about 4% overvalued. Now, taking that we do break the market down even further, which I'll show in a couple of slides, but we do think that the value category is undervalued in today's marketplace. And then when we break it up by sector, we still think that the energy sector is undervalued. And in fact, it's undervalued by far more than any other sector that we cover. Some of the other sectors that we think are fairly valued, probably include communications, consumer cyclical, healthcare, and utilities.

Dave Sekera:

And the thing that we've noticed over the first quarter is that there has been a market rotation going on out of some of those large cap growth stocks that did so well in 2020, and now into cyclical stocks. For example, the basic materials and industrial sectors have actually run up so much now that we think that those are probably two of the most overvalued sectors in our view, you know, and finally, one thing that we did see last year is a lot of mega cap stocks were overvalued. And because they're so large, they were actually skewing the market valuation higher than it would have otherwise been. What we've seen is that with that rotation, a lot of those stocks haven't come down in the first quarter is no longer skewing the overall market valuation too high. So here's a breakdown using the Morningstar style box of the different categories that we cover.

Dave Sekera:

As I mentioned, we do think that the value category is undervalued today, specifically the large cap and small cap parts of the value category. And interestingly, the large cap growth stocks are also now at the point where we think that they're pretty close to fairly valued as well. And so using that screen, let's take a look at some of these companies that we rate four and five stars and come up with a couple of different ways of looking at these. So for example, breaking them down by large value stocks and looking at stocks that we rate for stars, we then can also break it into looking at small value. And even some of those large growth stocks that we think are undervalued in today's marketplace. The other thing we provided at the end of the first quarter, it was a breakdown by sector of those four and five star rated stocks as a percentage of each of the individual sectors that we cover.

Dave Sekera:

So here in the energy sector, you can see that had the largest percentage of four and five star stocks. And then looking at like the healthcare sector, you can see that also was having a, a higher than average percentage compared to the other sectors of four-star stocks and utilities down here at the end, at the end of first quarter, also had a lot of good value for investors there. Again, using these screening tools that Karen was showing you, we can identify specific stocks, whether it's the energy sector, healthcare or utility sector, and again, looking for those with different star ratings, and then you can throw other categories on there as well. So for the most part, you'll look, you know, most of these are going to be companies that have a narrow or a wide economic moat. So among the catalysts that we see affecting both individual stocks, as well as the stock market in general, over the second half of the year, probably most importantly is the American jobs act proposed by the Biden administration.

Dave Sekera:

This is a $2 trillion framework, and that framework includes both traditional infrastructure programs, as well as what I consider to be non-traditional infrastructure programs. Now we expect it to be enacted by the summer, but we do think that it could be a headwind to the stock market valuation overall, as this plan incorporates several different tax increases, whether it's a corporate business tax or it's taxes on foreign earnings, those additional taxes could be a headwind to valuation moving forward. Now looking at the impact on individual company stocks, you know, the market always prices things ahead. And in that case, what we found is that stocks of those, you know, obvious beneficiaries to traditional spending have already moved up in price. Generally speaking, they're probably fairly valued to maybe even slightly overvalued at this point in time. However, we do see value in a lot of areas, especially in what I consider to be non-traditional infrastructure spending.

Dave Sekera:

So in this list here, I've gathered a couple of those stocks that our equity analysts think have a higher probability of being positively impacted by the infrastructure program going forward. So as the infrastructure program is rolling through Congress, you'll, we're certainly going to be watching that very closely and depending on what the final form and condition is of the plan, we will certainly be taking a look at some of these stocks and see if they deserve fair value increases. If they're the beneficiaries of that spending now probably the biggest risk to the market today is inflation and inflation expectations. So our base case is that we certainly do expect to see inflation ramp up this year. And in fact, in 2021, our economist is modeling in, you know, 2.3%. However, because there is enough excess supply in the overall economy, we expect that inflation will moderate and be in that 2.2, 2.3% level for the next couple of years.

Dave Sekera:

Now, having said that for investors that are certainly concerned about inflation may be running, you know, further than the fed may want it to run. You know, we have run through here and we've identified a number of different companies that we think actually would end up benefiting in an inflationary environment. So you can use your screening tools to look for those specific sectors, you know, specifically sectors like energy, which ended up holding their value in an inflation in their environment. You know, other sectors, maybe like the financial services sector that as interest rates move up in with inflation, you also would be able to benefit and see some earnings growth, as well as, you know, some of the other companies like here in the basic material sector, again, sectors that traditionally hold their value in an inflationary environment. We also are looking for stocks that have strong pricing power.

Dave Sekera:

So again, these are going to be stocks that generally are going to have a wide moat or at least a narrow moat. These are companies that have long-term sustainable competitive advantages and are going to have that pricing power to be able to push through their own cost, increases into their customers, to be able to hold their margins. You know, and finally, I know a lot of investors are always looking for income and especially in this low interest rate environment, you can use those screening tools in order to identify those companies that pay relatively higher dividends than other companies. And look for those companies that have that stable and consistent dividend growth over time. So with that, that concludes the prepared part of our presentation. And at this point, Karen and I would be happy to take questions regarding any of the material that we've presented today.

Karen Wallace:

Hi there, and welcome to the question and answer part of our program as our market strategists. Dave doesn't cover individual securities, so he'll stay away from answering any questions about individual stocks, but he's happy to take any questions you may have about market valuation and our outlook. And I'm happy to answer any questions about getting started with investing and screening for stocks, using Morningstar research and readings. Um, we've received a lot of great questions from you guys when you registered and, uh, lots more have come in during the presentation. As a reminder, if you'd like to submit a question, please use the zoom Q and a feature at the bottom of your screen. Um, let's get started. I have a great question here for Dave. Um, does Morningstar have an expectation for inflation and is inflation really a threat?

Dave Sekera:

You know, we do Karen and in fact, you know, other than a resurgence of the pandemic now, inflation is actually probably one of the greater risks that we do think about in the marketplace today. And in fact, inflation has definitely been picking up over the past couple of months. So I just noticed this morning, our economist published an article on morningstar.com and he did increase his projection for inflation up to 2.9% for this year. However, I would note that he does continue to believe that inflation will moderate. He'll probably stay at a little bit above 2% thereafter. And let me just give you a couple of reasons why so first, you know, a good amount of this recent inflation has really been due to supply constraints. And we think that those will normalize, you know, over the short term. The other thing that we're thinking is that consumer spending will probably shift back away from goods and towards services.

Dave Sekera:

And the second half of this year is that pandemic, you know, continues to recede. So when they think about spending last year, you know, with the different shutdowns and the lockdowns and so forth, you know, spending that did occur had really shifted away from those services where we've just had limited ability to be able to spend the money, you know, in those sectors and towards goods. And so as we see that, you know, shift back into services, that will take some of the pressure off of goods. Yeah. And in fact, over the longterm, you know, in a economist speak, you know, Preston they'll notes that he doesn't think the U S economy has closed as output gap yet. So in layman's terms, that just really means that we still continue to see over capacity in a number of different areas in the economy. And that essentially will act as a release valve for inflation from building up too much.

Dave Sekera:

So our base case, you know, inflation should remain contain, and the economy recovers. Now, as that happens, we would certainly expect the fed to first start tapering its asset purchase program. And then from there is when we'd start thinking about the fed, you know, looking at increasing, you know, the federal funds rate, but we really probably don't expect that to happen until, you know, into 2023, as far as interest rates go, you know, we don't specifically forecast interest rates, but personally I do expect that long-term rates should drift higher in the second half of this year. And we do think that over time, it should. And thinking about like the 10 year treasury specifically should get up to at least those, you know, inflation expectations, you know, over time. So as long as those interest rates don't spike up too quickly, I think the market should be able to handle those rates, you know, climbing back up towards pre pandemic levels now for wrong.

Dave Sekera:

And inflation does rise meaningfully, and we see inflation expectations stay higher for longer than, you know, we do think that that could be a negative impact on the market. I really that occurs, you know, two different ways, you know, first, you know, companies that don't have pricing power, they would see their margin squeeze as their costs are going up. And of course that then would lower their earnings and in turn, reduce their valuations. You know, second is that with higher interest rates, depending on how high they go and investors would probably start to price those higher rates into discounting, those future cash flows, you know, that we look at to come up with our evaluations. So in that case, even if earnings expectations remain relatively stable, you know, if you're, you know, discounting those at a higher rate, you know, that would cause you know, those, uh, those valuations to come back down.

Karen Wallace:

Thanks Dave, another question. I love this question. What's the best way for peers to avoid mean stocks and focus on a longterm sustainable investing strategy. Thank you. Whoever submitted this question. Um, I guess I most people on this webinar are familiar with what mean stocks are, but it can't hurt to kind of define them quickly. I mean, stock is, you know, a stock like GameStop or AMC that gets hyped up on social media and places like Twitter and Reddit. Um, they've had some huge price swings that aren't really based on any earnings reports or anything kind of fundamental going on with the company with GameStop that stocks actually had some pretty poor, fundamental fundamentals, profitability and metrics for years. And a lot of professional investors were kind of betting that game stock would go the way of blockbuster. You know, they were shorting the stock.

Karen Wallace:

If you look at the interest of the short interest, rather compared with the float, um, there were a lot more people in the market shorting the stock than there were shares available to buy, which is sort of a good environment for some goofy trading to have happen. Um, you know, an often a stock with sort of a troubled future that attracts short sellers will not have a lot of trading volumes. So short, small changes in demand like that can kind of move the price around quickly. Um, you know, these dramatic price swings and kind of like the fear of missing out on this stock position that people are talking about their huge gains. And they're also, you know, they're saying I got these gains at the expense of these big wall street traders and hedge funds. I mean, it definitely made for a dramatic story. Um, but I would caution that, you know, mean stocks aren't, you know, they're, it's not really a wealth creating strategy. Um, the stock doesn't have the fundamentals in place in the competitive advantage to really drive, um, long-term value creation to really like drive profits. Um, and this is this next question, I think kind of dovetails with that one nicely. Um, should I ever buy a stock that doesn't have a moat, Dave let's turn to you for that one?

Dave Sekera:

You know, and of course the short answer is yes. I mean, there's always going to be a price that something can be cheap enough to make it a good investment, you know, irrespective of whether or not we think the company has long-term sustainable competitive advantages. So while of course our preference is certainly to invest in those firms that we do believe have an economic moat, and that certainly helps protect investors, you know, over the long-term our valuation methodology does incorporate, you know, our views on whether or not a company has an economic moat. So when you see a no moat stock, that's rated four or five stars, you know, that does incorporate our views. And we do believe, you know, at that point there is enough margin of safety to justify an investment. Even if the company doesn't have a moat,

Karen Wallace:

Here's one about diversification as an individual investor. How do I know if I'm diversified? How many stocks should I own? Um, I can take this one. Um, there's really no, uh, prescriptive answers, uh, with investing like this because everybody's circumstances are a little bit different, but, um, one thing there's, there's two, well, there's a lot of different types of risks, but there's two types of risks that are kind of relevant here. There's company and individual security risk, which is kind of a risk that an individual stock might fall in price because of a non-market related factor, like poor management or, you know, a lawsuit, poor risk controls at the company. Um, and this is risk in excess of the overall stock market. It's not always rewarded with higher returns. It can be, um, you assume greater company risk when you invest in just like a handful of stocks.

Karen Wallace:

Um, so holding a lot of stocks reduces the company risk that you're exposed to the company risks that you're exposed to. I'm an investor holding hundreds stocks, for instance, assumes like, you know, very little company risk. Um, the problem is that it's impractical for most investors to kind of buy hundreds of individual stocks and keep close tabs on them. Um, you know, it's also kind of a challenge to make sure that you're diversified across different market sectors and different market caps. Um, that's kind of where mutual funds and ETFs come in. They're able to kind of reduce the company risk because they have those economies of scale. They have a million dollars in assets and mutual funds can afford to take, you know, hundreds of positions in hundreds of different stacks. Um, you know, but even mutual funds, can't diversify a way that market risk, which is the risk that, you know, the entire market will experience a decline in price. So, you know, even if you're diversified across, even if you hold every stock in the market and a very, very little company specific risk, you'll still be exposed to that market risk. So, um, let's see, uh, individual sectors. We have questions about individual sectors. What does Morningstar think of the healthcare sector? Does Morningstar think the Biden administration will force change in healthcare due to drug pricing? I'm going to give that one to date,

Dave Sekera:

You know, and actually the healthcare industry is a pretty interesting as a sector goes right now in that overall, we think that the sector is probably pretty, fairly valued, but what we're seeing is that there's a bit of a barbell shape in the stocks that we cover and that, you know, there are fewer that we consider to be three-star stocks. Then we see as a percentage in other sectors. And so there's really more stocks that we consider either to be overvalued or undervalued. Now, as far as, you know, the Biden administration goes, you know, at this point, you know, we don't really expect the Biden administration to make wholesale changes to the healthcare industry overall. So having talked to our sector director, you know, what we expect is that the goal of the Biden administration has really more to further expand healthcare access and insurance to an even greater percentage of the people, you know, in the U S.

Dave Sekera:

And so looking at how the healthcare sector has traded, you know, thus far this year, and, you know, even over the past few weeks, you know, it looks like, I think the market is coming around more and more to our view. So for example, a number of the large international pharma stocks, the pharmaceutical companies, you know, a number of those that we thought, you know, were undervalued, you know, earlier this year have now moved into three-star territory. There are still a couple out there that we rate four stars, you know, Merck and GlaxoSmithKline, you know, would be two that I would point out. So essentially we think the market might still be pricing in a little bit more, you know, price, reductions, and cost controls in pharma than what we're expecting, you know, plus I think this is just a good example of how that screening tool that you've showed earlier is, you know, can be used by investors, you know, to look for stocks, you know, within specific sectors, you know, screen for those that, you know, we rate, you know, four or five stars, you know, then narrow that down to those with, you know, a narrow and wide economic plus, I think it's also a good idea to, you know, go on the morningstar.com website and go to the individual company homepages, you know, for those stocks that either, you know, you're already invested in or thinking about investing in, you have to look and see if any of those have run up in price, such that they're now, you know, one star, two star stocks.

Dave Sekera:

And if so, then it's, you know, a good time to reevaluate those positions. And it might be an appropriate time to pair some of those down and take those proceeds and reinvest those back into other stocks that we think are under undervalued.

Karen Wallace:

Thanks, Dave, here's one about stock splits. How does a stock split affect the investing strategy for investors? I'll take this one. Um, the short answer is that it really doesn't, um, even though you'll have twice as many shares, um, the value of your investment is exactly the same. You know, it's like having a $20 bill or two tens, either way, you have the same, um, you know, overall amount of money. Um, sometimes the stock price will pop a bit when a split, some announced, but it shouldn't really affect the long-term valuation of a company, um, short and sweet there. Okay. So what is the impact of rising rates on the stock market? Dave? I think you already sort of touched on this one

Dave Sekera:

And in fact, you know, it's a good question and, you know, I think my opinion might be a little bit of an outlier right now, compared to what you might be hearing in, you know, the rest of the market. So again, you know, we do expect the interest rates probably will be, you know, drifting higher over the second half of the year. But having said that, I don't think a modest increase in interest rates are really going to impact the markets or specifically the equity markets, you know, very much in the short run. So in the media, you know, we've been seeing, you know, them, you know, blame a lot of the decrease in the tech stocks in like the first quarter and, you know, first part of this year on the increase in rates. But in our view, when we looked at those stocks, you know, at the end of last year, we just thought that they were just over valued.

Dave Sekera:

So I don't really think it's necessarily the increase in rates. I think a lot of is also just due to the market rotation out of a lot of those, you know, large cap growth stocks and into a lot of those, you know, smaller cyclical stocks, especially those, you know, in the value space that we thought, you know, were undervalued. So thinking about interest rates, you know, I don't know, I guess I would have to think that the 10 year US treasury would need to get, you know, well over two and a half percent probably start getting close to 3% before we think it starts to have a meaningful impact on stock valuations. And part of that is, you know, talking to a lot of different investors and again, you know, the proper way to determine the value of a stock today, at least in our view, you know, is doing that, you know, discounted cashflow analysis.

Dave Sekera:

And part of that DCF analysis is, you know, determining what is the right rate in order to discount that cashflow stream. So based on its weighted average cost of capital, part of that is, you know, having some sort of assumption for what you think that longterm risk-free rate is. And most of the institutional advisors that I've spoken with, you know, they've not brought down their, of the risk-free rate in their models all the way down to where the U S treasury is currently trading. So again, that's why I think two and a half probably closer to three is what most, most investors are utilizing. And then if we start getting much higher than that, then yeah. Then maybe that starts acting as a headwind to the overall markets.

Karen Wallace:

Okay, I'll let you off the hook. I'll take this next one. This is kind of a hard question. How do you know when it's time to sell a stock? Either one that's appreciated or one where I've lost money, how can I use the stock report to help me make that decision? Well, there are some very legitimate reasons to sell a stock and one, you know, one, maybe it's overvalued, Morningstar ratings can help you determine that because are one and two star ratings mean the stock is overvalued trading at a premium to its fair value. Um, another, you know, sometimes when stocks have a great run. Um, so this would be, I guess, answering the question, if you, you know, if, uh, if something has made money, um, the position might become a larger part of your overall allocation than you had originally intended. Um, you know, sometimes it feels counterintuitive to sell something in your portfolio.

Karen Wallace:

That's, that's been a great performer, but it's actually kind of a good way to de-risk your portfolio because you're removing some of that price risk there. Um, and if you, you don't have to sell the whole position, maybe just trim it back to 5% of your overall allocation or whatever you had kind of originally set it as, um, that concept is referred to as portfolio rebalancing. Um, there's also, you know, if you've lost money, um, or maybe if you haven't, you know, it's prudent to sell sometimes when you realize that like your original thesis for the stock, isn't on track either because, you know, maybe some of your original assumptions were wrong in your evaluation work, or maybe the fundamentals of the company just are kind of deteriorating since you bought it. Um, the thesis isn't quite there anymore. Um, it's usually not a good idea to throw in the towel after, you know, one negative earnings report, but if there's a lot of signs that the fundamentals are deteriorating, um, your thesis just doesn't hold up anymore. It's sometimes it's a good idea to cut your losses and redirect that money towards like a more promising opportunity.

Karen Wallace:

Why do some stocks beat their earnings estimates, but still decline Dave?

Dave Sekera:

You know, that's a good question. I think that also highlights pretty well. Now, part of the differential between trading and investing, I think, and, you know, there could be a couple of different reasons, you know, so first time it just could be the, you know, while the company beat expectations for that quarter, you know, depending on the outlook, you know, maybe the company ends up guiding down on its future earnings expectations during the quarterly earnings conference call. And the market will certainly, you know, price that into the value of the stock or other times, you know, maybe they beat the published earnings expectations, but maybe it missed the whisper number. So the whisper number, you know, sometimes the expectations in the marketplace, you know, especially at the end of a strong quarter, you know, we'll start going up at the very end of the quarter, but before the company reports, but you know, too late before, you know, sell-side analysts can actually incorporate that into their published earnings.

Dave Sekera:

And so if the company meets kind of that whisper numb or misses that whisper number, you know, even if they'd be kind of the published number again, you could see the stock, you know, trading down. Yeah. Having said that, yeah, I would advise investors, you know, not to get too caught up into that earnings, you know, that quarterly earnings release game. Again, to me, that's really reserved more for people that are trying to trade the stock than for the longterm investing. So in my view, you know, the best course of action, you know, pull up the earnings release, take a quick read through, you know, the earnings conference call will be available on the investor relations portion of the company's website. You know, take a listen to that. I really decide yourself, you know, has anything really materially changed from when you first made your decision to purchase that stock? And so if nothing has materially changed, you know, then in the short run, you know, if that stock price has gone down, you know, pretty materially, that might be a good time to actually be able to purchase some more stock after the market has, you know, unfairly pushed that stock price down.

Karen Wallace:

Okay. I realize we're over time, but I want to fit in two more questions if that's okay, this is a really good one. I'm bigger than the beginning investor in my twenties. Where should I start? So this might be the most unfun answer of the day, but I would start, um, if you work for a company and you have a 401k, especially if they offer a match, um, I would start there and I would take that match because that's free money. Um, you know, holding sort of a broadly diversified fund or an ETF, as we mentioned earlier, it's a great way to get exposure to stocks as an asset class, without have to having to worry as much that an individual company will have a large negative impact on your overall return. Um, you know, low cost index funds track the broad market. They give you lots of exposure to companies in different sectors or industries.

Karen Wallace:

Target date funds can be a great choice to, for young investors. You find the year that corresponds roughly to when you would retire turn 65 or, um, whenever you plan to retire. Um, most target date funds for investors who are younger than 40 are, um, invested in, you know, a mix of stock funds US and international. And then that mix shifts away from stocks and towards safer things like fixed income and cash as the investor moves toward retirement age. So you don't really even need to handle that. Do you risking of your portfolio as time moves on? Um, you know, I'm not saying that stock investing is a bad idea for beginners. I think, I think investing in low cost funds gives you the best chance of like building wealth with less risk. So that's what I would favor for like the core position of your retirement portfolio. But, um, if you want to pick stocks, it's probably best to start with sort of a portion of your portfolio amount, an amount that you can kind of afford to lose. Um, so, uh, let's, let's end on the question that I think we had that we, we got a lot of this question. Um, so based on the market valuation today, does Morningstar expect to pull back in stocks or a bear markets soon, Dave, it's all you. Yeah, well,

Dave Sekera:

Again, you know, we're not trying to time the market, you know, we're trying to, you know, give investors, you know, the best advice that we can to help them, you know, be able to make the best investment decision, you know, for their own portfolios. So again, while we think the market overall might be slightly overvalued, now that doesn't necessarily mean that we think the market will actually experience a significant pullback or certainly not, you know, a bear market yeah. Here in the near term. So again, you know, news flow, you know, different catalysts sentiment know can certainly change. We certainly could see, you know, some pullbacks, but I think really that just highlights the role of proper portfolio diversification, understanding your own individual risk tolerances, the time horizon that you have to invest and whatever specific investment goals that you might have. And, you know, doing a quick search out there on morningstar.com.

Dave Sekera:

You know, there's going to be plenty of articles out there to help investors, you know, consider each of those, you know, for their own individual circumstances. And I would say, you know, pullbacks really, depending on what the catalyst for that pullback is and your own situation, oftentimes those really can be viewed as opportunities to provide investors, you know, the timing to really be able to go back into the markets and be able to adjust some of those positions. You know, as you mentioned before that maybe if those positions start getting a little out of whack, it's a good time to be able to reevaluate and reposition yourself.

Karen Wallace:

Right. If you liked it at $50, you'd like it, and nothing's changed like a better at 30. Right. Okay. Well, thank you so much for joining us today and thanks for all your great questions. I hope you enjoyed this Morningstar Classroom event, please remember to check your email because we'll be sending everyone who registered a follow up email. Thank you and have a great rest of your day.