Ultimate Stock-Pickers Returns to Morningstar

By Greggory Warren, CFA | Stock Analyst

Ultimate Stock-Pickers is a concept we started developing at Morningstar a few years ago. The basic rationale behind the strategy is fairly simple: to cross-check our stock research against the opinions of professional money managers (which we garner through the holdings, purchases, sales, and commentary derived from their investment portfolios).

As you probably already know, the stock analysts at Morningstar spend the majority of their time hunting for quality companies that are trading at attractive valuations. We would, however, be remiss if we failed to acknowledge that a whole host of individuals outside of Morningstar are actively engaged in the very same effort. By tapping into the fruits of their labor, we believe that we can both confirm some of our own stock calls and also potentially uncover investment ideas that might have not been readily apparent.

Along with the cadre of stock analysts who currently sift through a universe of some 2,000 publicly traded companies, there is another full team of analysts at Morningstar who spend the majority of their time researching some 2,000 mutual funds. The combined efforts of both of these research groups put us in a unique position to monitor both sides of the coin. As our stock analysts are following the fundamentals of individual firms, our fund analysts are tracking the actions and performance of the professional money managers who routinely sift through the same universe of stocks in search of investment ideas.

We're not interested, though, in what all investment managers think--just what the best in the business are doing. As such, we maintain a list of around 25 well-respected managers that we believe are worth monitoring on a regular basis. The list includes both the obvious, like Warren Buffett at  Berkshire HathawayBRK.ABRK.B, and the not so obvious, such as Harry Burn at  Sound Shore SSHFX or Nicholas Kaiser at  Amana TrustAMAGX. In keeping with our desire to continuously tap into the best investment minds in the business, we expect to update this roster from time to time, replacing managers that we feel might have fallen from grace or who no longer meet our selection criteria with others who are either performing better or are more suited for the list we are striving to maintain.

How Ultimate Stock-Pickers Works
Most institutional investment managers are required to file a Form 13-F each quarter with the Securities and Exchange Commission (SEC) disclosing their investment positions. Morningstar also receives monthly updates on the holdings of many different mutual fund managers. Sifting through the data, we are able to construct a consolidated list of holdings for the managers on our roster and track any meaningful changes in their equity positions.

Once this task is completed, we assess the relative attractiveness of each individual security by how many funds actually hold it and whether or not they've been adding to (or subtracting from) the position. We also look at the percentage that each security constitutes within the equity portfolios of each of the managers on our list, determining the level of conviction they have in a particular name by the amount they have committed to it (relative to their total portfolio). All of this allows us to compile a list of top purchases and sales, which we can then cross-reference against our own stock ratings to determine if a particular security is still selling at an attractive enough valuation to warrant purchasing or, at the very least, further investigation.

There is a notable drawback to this approach, though. The data we rely on is not always as timely as we would like it to be, as investment managers have 45 days from the end of each quarter to file their 13-F with the SEC. While we alleviate some of this by tapping into our own database of fund holdings, which gets updated more frequently, there is always going to be some lag between the time at which a manager decides to buy or sell a security and when we actually find out about it. Even with this limitation, we still believe we're on to something with the Ultimate Stock-Pickers concept and, as such, are now devoting more time and effort to the idea. With a full team of analysts now committed to Ultimate Stock-Pickers, we think we'll be able to not only turn over more stones than we were in the past but also provide more timely analysis and commentary as we work our way through the process.

Greater Focus on Stock-Picking
Instead of presenting our ideas in the form of a portfolio as we've done in the past, we're now focusing the majority of our efforts on what managers are actively buying and selling. We will continue publishing the list of managers we admire, highlighted in a table called the Investment Manager Roster on the Ultimate Stock-Pickers homepage (right-hand column). We'll also have two separate watch lists, the Ultimate Stock-Pickers' Purchases and Ultimate Stock-Pickers' Sales that highlight the most recent high-conviction purchases and sales of the managers included on our Investment Manager Roster.

Over the course of the week, we'll spend some time going through these lists and talk about the best way for investors to use them in their search for new investment ideas. We also have two articles slated for publication toward the end of this week that take a much deeper look at two different asset managers: Jensen Investment Management, which runs the very successful  Jensen Fund JENSX, and  Fairfax FinancialFFH, a Canadian property and casualty insurance firm, which although not currently on our list of managers, does have a pretty remarkable track record of investment performance and, surprisingly, was a large purchaser of U.S. equities in the fourth quarter of 2008. So, we hope that you'll join us as we relaunch the Ultimate Stock-Pickers feature on Morningstar.com.

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