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The 10 Cheapest Stocks in the Wide Moat Focus Index

We take an in-depth look at the new constituents of Morningstar’s Wide Moat Focus Index and highlight the stocks that are most attractive today.

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In December, the Morningstar Wide Moat Focus Index swapped out 11 stock positions.

To be included in the Wide Moat Focus strategy, a company must have an economic moat rating of wide (we think they have advantages that will fend off competitors for at least 20 years), and their shares must be among those trading at the steepest discount to their fair value estimates in our coverage area. (Our fair value estimates are determined through independent research by the Morningstar Equity Research team.) Only U.S. stocks are included in the index.

The index consists of two subportfolios with 40 stocks, which are reconstituted semiannually, but with staggered rebalancing quarterly. After the December reconstitution, half of the portfolio swapped out 11 positions. The net result is that the index now holds 50 positions. 

The following 11 stocks were added to the index:  

On the flip side, 11 stocks were removed because their price/fair values rose or for other reasons. 

The table below lists the 10 cheapest stocks in the index, ranked by price/fair value. The median stock in the Wide Moat Focus Index is trading at a price fair/value of 0.87. By comparison, our entire coverage area is trading at a median price/fair value ratio of 1.03--just a hair below the 52-week high of 1.04 reached in September. 

Some Smaller Position Sizes
Some readers have noticed that the index contains positions of varying sizes after reconstitution. (Previously, the entire index reconstituted quarterly and all positions were set back to equal weight.) Of course, market action can affect position sizes, but our reconstitution method also plays a big part. Because the two subportfolios hunt for attractively valued wide-moat stocks at different points in time, they do not overlap perfectly. Some stocks appear in both subportfolios, while others are present only in one. 

In September, we added pharmaceutical company  Bristol-Myers Squibb (BMY), and we added it again during the December reconstitution, so it is now a full (2.5%) position. We also added  Lowe's (LOW) in September and again in December, and our position in the home-improvement retailer is now 2.4%. In September, we added agricultural equipment-maker  Deere & Co (DE) but didn't add it during the December reconstitution, so it remains a smaller position (1.49%). 

LinkedIn was removed after the closure of  Microsoft's (MSFT) buyout in December. In addition,  Western Union (WU) was removed in December as well as September, so those two positions are now completely out of the index. Healthcare IT company  Cerner (CERN) was removed in the September reconstitution, but after a pullback (the stock has lost over 16% over the trailing three months), the price/fair value fell within our buy zone at the time of the December reconstitution, and a smaller position (1.25%) remains in the index.

Peformance Attribution
Over the fourth quarter of 2016, the Wide Moat Focus Index returned 3.6%, trailing the S&P 500 by 19 basis points. Financial services was the biggest contributor to returns over the quarter, followed by consumer cyclicals. Among individual holdings, strong performances from  Wells Fargo & Co (WFC),  Time Warner (TWX),  CSX Corp (CSX),  US Bancorp (USB), and  Bank of New York Mellon (BK) buoyed the return. (All of these stocks, not coincidentally, are also found in the list of stocks being removed from the index because their price/fair value ratios have moved outside our buffer zone.)

Among the detractors, exposure to the healthcare sector weighed the most, followed by technology. Among individual stocks,  McKesson (MCK), Cerner,  Amgen (AMGN),  Amazon.com (AMZN), and  Biogen (BIIB) were the biggest laggards.

Click here to see the top 25 positions in the index. (Premium members can see  all 50 positions.)  

Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.

Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.