5 Wide-Moat Stocks to Buy After Earnings

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services chief U.S. market strategist, Dave Sekera, to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.

Dave, on your radar this week: earnings season. You’re watching a few companies this week, starting with Apple. What will you be listening for there?

Dave Sekera: Good morning, Susan. It is going to be another busy week. We’re about halfway through earnings period, but we certainly have a couple more big names coming out this week. First off is going to be Apple.

Now, Apple stock is up about 50% year to date. So as such, it’s now actually a 2-star rated stock because it’s now trading at about a 30% premium to our fair value. Between that type of movement that we’ve seen thus far this year and where we think that stock is valued compared to our intrinsic valuation, I think that sets a pretty high bar for Apple management to be able to satisfy the market coming into earnings this quarter, especially when you look at the earnings over the last week, with a lot of these other mega-cap tech stocks really outperforming and giving pretty good guidance last week.

With Apple, the key items here is I really want to hear what their view is on the state of the consumer. Both AT&T and Verizon, in their earnings, they noted slower cellphone sales, so I want to see whether or not that also extends to the iPhone. Now, of course, Apple is going to be launching the new iPhone 15 in another three months or so, so this number this quarter may not necessarily be as important as the amount of demand they’re going to see when the new phone is coming out. But again, I think it’ll give some good insight as to the consumer.

We also want to hear about their service revenue. Apple has expected relatively dour macroeconomic headwinds to weigh on digital ads and on gaming. But with the global economy and the U.S. economy being better than expected, this actually should be a pretty positive tailwind for them.

And then of course, lastly, what are they doing in artificial intelligence, specifically the large language models that everybody is talking about? I think the market really wants to hear what they’re up to, what they have coming out, and just make sure that Apple isn’t falling behind the competition as far as artificial intelligence goes.

Dziubinski: Got it. We also have another tech-related name reporting this week, a biggie: Amazon. What are you looking for there, and what do we think of the stock going into earnings?

Sekera: Amazon stock is also up 50% year to date, and that takes that stock into the 3-star territory. Now, it’s still trading at a slight discount, a couple percent below our fair value estimate. So I think that that’s going to be under less pressure coming into earnings than Apple is going to be.

Now, with Amazon, there’s really three parts to their business. There’s the e-commerce, and that’s the retail part of their business, their cloud, and then their advertising. On the e-commerce side, we’re expecting that to be in line with expectations, so I think the real focus on our analytical team is going to be with the cloud, with Amazon Web Services, known as AWS. AWS has been a key driver for the company, but growth there has been decelerating.

Now, the second-quarter guidance that they gave was below expectations. And our analyst that covers that, Dan Romanoff, he noted that the Microsoft Azure, which is their cloud business, was actually slightly better than expectations when they reported last week. So hopefully I think Amazon’s going to look pretty good as far as their cloud business.

And then the advertising business, which I think has been kind of underappreciated by the market, how much value is in that specific area. Now, their advertising had been slowing earlier this year, but it was actually holding up better than what we saw at Alphabet and Meta. And of course, both Google and Meta did have strong results last week, so I do think that portends well for Amazon this week.

Dziubinski: Got it. Besides these two tech heavyweights, what other companies are you eager to hear from this week and why?

Sekera: I’m really breaking it down into three different categories of what I’m watching. So first, there are the real economy stocks. As much as last week was all about the online world, this week I think it’s all going to be about the real in-person world. I also want to hear more about the state of the consumer from a couple of different companies, and then looking at a couple of stocks more from a thematic point of view.

In the real economy world, we’ve got Caterpillar, Eaton, Johnson Controls, and a couple of other companies. And recently, I spoke with Josh Aguilar, he’s our equity analyst that covers a number of our industrial names, just kind of getting an idea from him what he’s thinking coming into the week. And he joked around, “Recession? What recession?” And he really noted that of the companies that’s reported thus far, the long cycle businesses have still remained very strong. Some pockets here and there for weakness in the short cycle. But really, what we’re looking for are those companies to see who’s managed through the supply chain disruption the best. Those are the companies and the stocks we think are going to perform over the next couple of quarters.

And also, with second-quarter GDP being better than expected, having come out at 2.4%, that’s well above what both market and management expected at the beginning of the quarter, when they were giving guidance last April. So I do think that good economic performance will be a good tailwind for these stocks coming into this earning season. However, we do think that the economy, the rate of economic growth, is going to slow and not just this quarter but for the next couple quarters. So I want to hear what these companies are seeing themselves.

As far as the state of the consumer, now, a lot of retailers don’t report until more into early to mid-August, but I am looking for a couple of early indications. We do have Starbucks coming up, so that’s a 3-star rated stock. Now, you can argue whether or not coffee is discretionary, but I do think it does provide some insight into spending here in the short term.

And then two food stocks. We have Kellogg, which is a 4-star rated stock, and then Kraft Heinz, that’s a 5-star rated stock. And I’m going to be listening there for indications of just how much inflation does continue to keep pressuring the consumer and consumer spending, things like whether or not people are trading down into private-label items as opposed to branded items.

And then lastly, a couple of thematic stocks. We have a Zimmer Biomet who’s going to be reporting. That’s a 4-star-rated stock. We’ve heard from some of the healthcare insurance companies, just that they’ve been seeing a big pickup in healthcare services. So again, I think that’ll give us good insight into the medical-device makers. And of course, we’ll also be looking for insight there into Medtronic.

And then go looking at the lithium guys. So we’ve got Albemarle reporting this week. That’s a 4-star-rated stock. Now, lithium prices, they’ve dropped pretty precipitously thus far this year, and I’m really looking to see whether or not they think those prices have bottomed out and whether they’re going to start coming back. Again, we have a very long-term positive view on lithium prices over the course of the next decade, just based on the amount of demand that we see out there as the market starts switching into electric vehicles.

Dziubinski: Got it. Let’s pivot away from earnings and talk about economic reports. What of those are on your radar this week, and what might that mean for the market?

Sekera: Yeah, there’s several here. Just looking at the calendar, we’ve got PMI numbers, ISM number, payroll numbers. And the market’s going to be looking at these, arguably whether or not these are leading indicators for the economy. But more I think what we’ve seen over this earning season and the last two months really is the market’s been coming around to our point of view, that we do see a slowing rate of economic growth, but we’re not forecasting a recession. So when these metrics come out, I do think they’re going to show some weakness, but we’re not looking for any kind of dramatic drop or pullback. And so, as long as the metrics come out in line, I don’t think there’s going to be much impact in the market.

Now, if they are significantly below expectations, that we could certainly see a selloff as the probability of a potential recession rises, but that’s not our expectations this week. And in fact, I think really people are going to be focused much more on earnings and guidance than these economic numbers.

Dziubinski: Got it. Let’s move on to some new research from Morningstar. And today we’re going to cover several reaction pieces that our analysts published last week around the Fed meeting and some of the high-profile companies that reported last week.

So first, let’s talk about the Fed meeting. As expected, the Fed raised rates by 25 basis points last week, bringing the fed-funds rate up to a target range of 5.25 to 5.50. So did the Fed say anything that changed our interest-rate outlook, Dave? And what are we expecting as far as interest rates go for the rest of this year and the beginning of 2024?

Sekera: First of all, Susan, I just have to say, after listening to the conference call, and I’m going to get some pushback on this and it’s certainly arguable, but I do think that Powell has really been the best Fed chair over the course of my career. And it’s just really interesting listening to him be able to respond to a lot of those reporter questions.

Now, I don’t think there was anything new that we heard during this press conference. I do think he did a great job. He stuck to his talking points, wouldn’t let himself get trapped by some of those reporter questions. And again, yes, you can certainly argue that the Fed was slow to start tightening monetary policy when inflation was just starting to ramp up. But since then, I think the Fed really did what needed to be done. They raised rates at the steepest and fastest rate than what we’ve seen since the ‘80s. We also have the quantitative tightening, which is still out there, and I think it’s kind of fallen out of the headlines, but we still see the Fed tightening monetary policy that way.

I think the real main takeaway is we think this is the last hike as far as this monetary tightening cycle goes. We do think that inflation will continue to keep moderating over the second half of this year. We do think that the economy will slow over the next three quarters. And as such, we really think that the next Fed move is actually going to be to start loosening monetary policy, and that really could happen possibly as soon as next February.

Dziubinski: Wow. Now, long-term rates spiked last week after some GDP numbers came out. Remind viewers, Dave, what’s your bond market forecast?

Sekera: Thinking about the longer-term part of the curve, as you noted, we did see them spike up last week on the GDP report being higher than expected and some other technicals in the market. So right now, the 10-year U.S. Treasury is pretty close to 4%, and that’s pretty near the high point that we’ve seen over the past year or so. Now, we generally think that U.S. long-term rates are going to decline over the next, call it, six to 18 months. So we do think now is a good time to start extending duration more from the shorter and middle part of the curve to the middle and even some of the longer part of the curve. Looking at our forecast for the 10-year U.S. Treasury, our U.S. economics team, they look at about 2.75% on average in 2024, and then coming down even further to about 2.50% on average in 2025.

The other part of the bond market that I watch is the corporate bond market and credit spreads there. They’ve tightened pretty significantly since the beginning of the year. So at this point, I don’t really think they’re as attractive as what we thought that they were coming into the year. But where they are right now, I still think they’re probably adequate in order to compensate for downgrade and default risk based on our economic outlook.

Dziubinski: Got it. Let’s move on to some commentary from our analysts last week about some high-profile companies that reported. Two that I’d like to start with, you mentioned earlier in the show, and that’s AT&T and Verizon, they both reported last week. Any update there to the fundamentals and our long-term outlook for the companies? And did either company provide more information regarding the issue that we heard about earlier in July about lead in their cable sheathing?

Sekera: Yeah, from a fundamental point of view, our takeaway is that both companies actually reported pretty solid earnings, so there’s really no problem as far as that goes. But it was interesting, and I talked to Mike Hodel, who’s the equity analyst that covers that company, and he really noted he thought the company are taking different paths in how they’re addressing or at least communicating to the market on the lead issue.

So as far as Verizon goes, they really didn’t provide much new or additional information. And in fact, I don’t think they really answered much in the way of questions on that matter. At this point, they’re really focused on their own internal investigation, and as that proceeds, they’ll show additional market information.

Whereas Mike actually really highlighted in his mind: He thought AT&T struck a much more what he called a defiant tone as far as this issue goes. And I’d note, I think AT&T has been more proactive than Verizon. They’ve provided to the market information regarding the scope of the lead sheath cable that’s out there. And they’ve also noted that they’ve been working with different regulators, they’ve been working with the unions over decades now in order to ensure safe handling of that lead sheath cable.

Now, either way, we continue to believe that neither company is going to end up facing really very significant legal liabilities on this issue. So really, what we’re thinking about, most companies or both these companies will probably incur some additional short-term expense. So we’ll see that they’re going to replace those cables sooner rather than later. But our long-term outlook is still the same. We still think that this industry is going to act more like an oligopoly going forward, that we’ll see less price competition, which will then lead to better margins. At this point, both of those stocks are still rated 5 stars. They trade at about a 40% discount to fair value, and both of them pay a pretty hefty 7% dividend yield right now.

Dziubinski: Let’s move on to Microsoft. Now, Morningstar raised its fair value estimate on the stock by about 10% after the company reported last week. Why?

Sekera: We did bump up our fair value estimate to $360 a share from $325 a share. Still leaves it in that 3-star territory. And that fair value increase is based on a couple of different factors; really no one individual factor led to it. As far as their cloud business goes, I think the Azure results were better than expected from more of an early stages within artificial intelligence. We’re starting to see that beginning to materialize, and some earnings and some revenue coming in from that. And the macroeconomic pressures are still there. They’re not getting any worse though, so I think it’s really a combination of all of that that helped us bring our fair value up on that one.

I would just note that Microsoft is up about 40% thus far this year. It has moved from a 4-star stock down to a 3-star-rated stock. So I would just note for investors, now that it’s at fair value going forward, that just says that we believe that forward returns will be pretty much in line with the company’s cost of equity.

Dziubinski: Got it. Morningstar also raised its fair value estimate on Meta last week, by about 12% after it reported earnings. What drove that increase, and how is Meta stock looking today after that fair value increase?

Sekera: Yeah, it’s funny, I talked to Ali Mogharabi, who’s the analyst on that one, after the results. And I think it was more what didn’t go well for Meta this quarter? Essentially looking at the results here, they had increased user base, increased engagement, all of that leads to improved monetization, which of course then leads to faster revenue growth. The company is still continuing to focus on cost control and efficiency, so we’re looking for longer-term margins to improve there as well.

And to be honest, I really have to compliment Ali Mogharabi on this one. He really stuck to his long-term investment thesis throughout all of 2022. That’s when the stock was plummeting throughout the year because people were concerned about excess spending on the metaverse. A lot of consensus, a lot of the other Street analysts there, they were just following that stock price down.

However, at this point, the stock has now risen. It’s gone from $120 a share at the beginning of the year now to $325. So that’s really taken it from being one of the most undervalued stocks we cover at the beginning of the year. It was 5-star-rated at that point. It’s now 3 stars. It’s really trading within that fair value range. So again, now that it’s at fair value, I’d expect the future returns to be in line with that company’s cost of equity.

Dziubinski: Got it. And then Alphabet also reported last week, and we didn’t change our fair value estimate after earnings on that one. How did earnings look? And are there any changes to our take on fundamentals based on the results?

Sekera: As a side note, so Alphabet’s actually covered by the same analyst as Meta, Ali Mogharabi. And I think this is another good example of how keeping your investment thesis really focused on the long-term prospects of the company can pay off for you over the longer run.

As you noted, we didn’t change our fair value estimate after they reported earnings, but we had actually already bumped up our fair value estimate a little bit before their earnings release came out. And that increase in the fair value estimate just really accounted for some updates and some changes in our view regarding their cloud business, just how much more demand AI is going to drive computing-power needs as well as more data-storage needs.

Now, as far as this quarter goes, our takeaway earnings were impressive, fundamentals were positive, the outlook remains positive. I think the main takeaway with Alphabet is that the market had been overly negative, in our view, thinking about how much AI might take business away from the search business. But at this point, I think the market is now coming back to our point of view.

Dziubinski: Got it. It’s time to move on to the picks portion of our program. This week, Dave, you’ve brought us five wide-moat stocks to buy after earnings. Before we dive into the specific names, remind viewers what we mean by “wide moat” and why we think it’s important.

Sekera: Yeah, so an economic moat rating is really just our assessment of whether or not we think a company has long-term durable competitive advantages. It’s a very Warren Buffett, Graham and Dodd-esque type of analysis. Is this company going to generate excess returns on invested capital over the long term as compared to its weighted average cost to capital? And of course, the more returns that a company can generate over its cost of capital, the longer it can do that, the more valuable that stock should be today.

Dziubinski: Got it. Your first pick this week is one of the magnificent seven stocks that we actually talked about earlier in the show—and it’s Alphabet.

Sekera: Yeah. And in fact, not only is that one of the magnificent seven stocks, that’s actually the only one now that’s still undervalued. As a reminder, coming into the year, six of those seven stocks were very undervalued. They were rated 4 or 5 stars. They’ve all run up in price. Alphabet has also run up in price, but at this point it’s still trading at a 18% discount to our fair value, so that puts it in that 4-star category. And its wide moat is based on a combination of its network effect as well as its intangible assets.

Dziubinski: Got it. Now you’ve talked before on the show about how overvalued tech is in general as a sector, but your next stock pick is actually a tech stock. Which one?

Sekera: Even though a sector itself, from a fair value basis, might be overvalued, of course there’s always going to be individual stocks that might be trading behind. And one here that we’re focusing on right now is Taiwan Semiconductor. That’s TSM. Now, most recently we did maintain our fair value estimate after earnings came out. Here, in the short term, there is a lot of pressure on this company. In fact, revenue for 2023, we forecast it’s going to be down 10% just based on lower short-term demand for semiconductors.

But we do think this company will be a beneficiary of AI growth over the long term. In fact, looking at our model here for specifically its AI products, we’re looking at about a 50% compound annual growth rate for the next couple of years. And in fact, that’s going to take AI as a part of its revenue up to 17% of the company’s revenue by 2027. And I suspect that that, of course, is going to be a very high margin, very profitable part of their business.

The problem here with this stock is that there’s a lot of overhang because of concerns of geopolitics. And again, it’s a low probability, but high severity event that if China were to invade Taiwan, that of course really would wipe out a lot of the value of this company here. And of course, that’s why it’s trading at a 26% discount to our fair value and it places it in that 4-star category. But fundamentally, its wide moat is going to be based on a combination of its cost advantage and its intangible assets.

More specifically, looking at semiconductors and looking at that sector, there’s a lot of barriers to entry, very high capital requirements to be able to build the most technologically advanced chips. That’s why we do think that Taiwan Semi does have that wide economic moat, which will help them generate excess returns for the next 20 years or so.

Dziubinski: Got it. Now your next pick this week is actually an old familiar name in the aerospace and defense industry that’s renamed itself. It’s new name is RTX, but it’s formerly known as Raytheon. Why do you like it?

Sekera: Right now I’d say it’s a little bit of a story stock. That stock dropped about 10% last week. The company did reveal that it’s Pratt & Whitney engines are going to have to be inspected for microscopic cracks. We did adjust our model for that. We reduced our 2023 free cash flow and incorporated that cost. However, we think the market’s probably overestimating the issue and overestimating the risk here. And I think we got into one of those short-term sell-first, ask-question-later kind of momentum.

And in fact, they also did release their earnings and we actually increased our fair value estimate here at $112 a share from $106, based on strong bookings and strong resupply contracts. Right now, that stock’s trading at a 23% discount to our fair value, puts in that 4-star territory, and it pays you a pretty decent yield at about 2.5%.

Its wide moat is based on switching costs and intangible assets such as their patents and their certifications. And our analyst noted that products here are really difficult to replicate, highly integrated mission-critical products. So again, those switching costs are going to keep people from really being able to move to competitors in a short-term basis.

Dziubinski: Got it. And lastly, the healthcare sector’s about fairly valued, but your final two picks this week are both healthcare stocks. Tell us about them.

Sekera: The first one’s actually one of my favorite healthcare plays. I’ve talked to our analyst on this stock a number of times, and that’s GSK. It’s another one of these stocks that renamed itself. It might be better known as GlaxoSmithKline. But again, it’s trading at a 34% discount to our fair value. Puts that in 5-star territory. Pays almost a 4% dividend yield.

GSK is one of the largest global pharmaceutical companies out there. Has a portfolio of drugs across a number of different therapeutic classes—respiratory and cancer being two of the larger ones. It also does develop and manufacture and sell vaccines. Although I would note they weren’t of involved in those mRNA COVID vaccines.

Now the stock, it got hit hard in mid-2022 over concerns of product liability from one of their products, Zantac. So we do think that there is going to be some costs, some liabilities that they’re going to have to pay out, but we think the market is overestimating the potential liability.

The other stock I wanted to highlight this week is going to be Biogen. It’s ticker BIIB. It’s trading at about a 20%, maybe 19%, discount to fair value here. Four-star-rated stock. For those of you that haven’t heard of it, it is a biotech company. Its focus is on multiple sclerosis and cancer. Most recently, they did get FDA approval on one of their Alzheimer’s drugs, so that’s now going to be covered by Medicare and Medicaid. So that’s going to be a good benefit for them going forward.

And I know our analyst has looked at several drugs in phase 3 trial for neurodegenerative diseases. See, I haven’t had enough coffee yet myself this morning. So again, coffee, not discretionary.

Dziubinski: That’s right.

Sekera: But again, another wide-moat-rated stock. And again, that wide moat is going to be based on intangible assets, and like a lot of other pharmaceutical companies, those intangible assets are the patents that they have, as well as, in this case, high barriers to entry in the biosimilar drug market.

Dziubinski: Got it. Thanks for your time this morning, Dave. Go get yourself some coffee. Dave and I will be back next Monday, live at 9:00 a.m. Eastern, 8:00 a.m. Central. And in the meantime, like this video and subscribe to Morningstar’s channel. Have a great week.