At Morningstar, we take an owner-oriented approach to stock investing. What does that mean? When investors buy stocks, we don't think they're just buying tickers or stories. Rather, they're buying partial ownership in companies. As such, we think it's important to understand a company's fundamentals before purchasing its shares.
Our approach to stock investing boils down to three basics: having an intimate knowledge of the company's sustainable competitive advantages, determining what its shares are worth, and then only buying the stock when there's a significant margin of safety in doing so.
Let's unpack that a bit.
We encapsulate our opinion of a company's competitive advantages in the Morningstar Economic Moat Rating. From our perspective, these are the types of companies that are able to effectively fend off competitors and earn high returns on capital for years to come. A company whose competitive advantages we expect to last more than 20 years has a wide moat; one that can fend off their rivals for 10 years has a narrow moat; while a firm with either no advantage or one that we think will quickly dissipate has no moat.
Our fair value estimates are our take on what we think a company's shares are worth. We look beyond fleeting metrics, such as a company's recent earnings or any stock price momentum. Rather, we calculate fair value estimates based on how much cash we think a company will generate in the future. Our fair value uncertainty rating--depicted as low, medium, high, very high, or extreme--depicts the level of uncertainty around our fair values estimate, based on things like a company's sales predictability, operating and financial leverage, and exposure to contingent events.
Lastly, the Morningstar Rating for stocks indicates whether a stock is undervalued (4 or 5 stars), fairly valued (3 stars), or overvalued (1 and 2 stars) based on where a stock's market price is relative to our fair value estimate, adjusted for uncertainty.
This guide takes a deeper dive into our process for evaluating and rating stocks and provides useful insight into how to make the most of our company reports.
What Makes a Moat?
The Morningstar Economic Moat Rating
The Morningstar Fair Value Estimate
Why Do Stocks' Fair Value Estimates Change?
The Morningstar Rating for Stocks
The Morningstar Rating for Stocks Do's and Don'ts
How to Use Morningstar Ratings to Find Quality Stocks
Quick Definitions: Key Morningstar Terms Economic Moat