For roughly the past decade, our primary objective with Ultimate Stock-Pickers has been to uncover investment ideas that our equity analysts and top investment managers find attractive, in a manner timely enough for investors to gain some value. As part of this process, we analyze the quarterly and monthly holdings of 25 separate investment managers: 21 managers oversee mutual funds covered by Morningstar's manager research group and four Stock-Pickers run the investment portfolios of large insurance companies. As the data from their holdings becomes available, we identify trends and outliers among their holdings as well as meaningful purchases and sales that took place during the period under examination.
In our last article, we walked through our early read on our Ultimate Stock-Pickers' individual purchasing activity during the second quarter of 2022—focused on high-conviction and new-money buys that were made during the period, based on the holdings of almost all our top managers. Now that all Ultimate Stock-Pickers have reported their holdings for the period, we think it is appropriate to examine our managers' high-conviction purchases and sales in aggregate. As stock prices have changed since our Ultimate Stock-Pickers made their buying and selling decisions, we urge investors to analyze securities at current valuation levels before making any investment decisions—we will provide our fair value estimates, moat ratings, stewardship ratings, and uncertainty ratings to help them along the way.
Morningstar's analysis shows seven of the top 10 conviction holdings have a wide economic moat, with the other three having a narrow moat. Furthermore, seven of the 10 companies composing the top 10 high-conviction purchases list have a moat, an increase from last quarter, where only four of the 10 names had moats. On the conviction sales list, eight out of the 10 names were moatworthy.
Considering that many of the Ultimate Stock-Pickers are long-term investors, we were not surprised to see that half of the names composing our top 10 conviction holdings list were the same as the prior quarter; however, we identified higher turnover than in our last report. Alphabet GOOGL (Google’s holding company), Microsoft MSFT, and Comcast CMCSA retained the top three spots on our list with 18, 16, and 16 funds holding, respectively. Our Ultimate Stock-Pickers’ conviction holdings favored the financial services sector this quarter with four companies making the top 10 list, a departure from last quarter’s preference for communication services. Our Ultimate Stock-Pickers continue to hold names from the technology and communication services sectors, each representing two companies on our list. Our current fair value estimates imply that at the time of writing, three of the firms on our top 10 conviction holdings list—Apple AAPL, UnitedHealth Group UNH, and Marsh & McLennan Companies MMC—are trading at a premium and therefore overvalued. However, the remaining names on our top 10 conviction holdings list all trade at a discount to Morningstar’s fair value estimates, with Comcast, Amazon AMZN, and Alphabet all trading at about 35% below our implied valuation.
All the names on our top 10 conviction holdings list were held by at least 11 of the funds we examined. In this edition of Ultimate Stock-Pickers, we’ll take a closer look at Comcast, which continues to generate sustained interest and is the only 5-star stock on our Ultimate Stock-Pickers’ Top 10 Stock Holdings list.
Wide-moat Comcast was held by 10 funds at the time of this article’s writing. This medium uncertainty stock currently trades at a discount to Morningstar analyst Michael Hodel’s fair value estimate of $60. The core cable business owns networks capable of providing television, internet access, and phone services to roughly 61 million U.S. homes and businesses, or nearly half of the country. About 56% of the homes in this territory subscribe to at least one Comcast service. The acquisitions of NBCUniversal (CNBC, MSNBC, USA, NBC broadcast network, several local NBC affiliates, Universal Studios, and several theme parks) and Sky (dominant television provider in the U.K.) have extended the company’s position.
Hodel notes that Comcast’s core cable business, which accounts for more than half the firm’s value, enjoys significant competitive advantages but will likely see growth slow as competition for incremental customers heats up. NBCUniversal isn’t as well positioned but holds unique assets, including core content franchises and theme parks, that should help the transition away from the traditional television business. Overall, Hodel expects that Comcast will deliver modest growth with strong cash flow for the foreseeable future.
Comcast’s cable business has steadily gained broadband market share over its primary competitors, phone companies like AT&T T and Verizon VZ, as high-quality internet access has become a staple utility. Hodel estimates that the firm has increased broadband market share in the areas it serves to about 67% from about 59% five years ago and 52% a decade prior. Comcast’s customer base in the typical market area is twice the size of its rivals’, with that gap far larger in areas where the phone companies haven’t invested in recent years. With a network than can be upgraded at modest incremental cost, Hodel anticipates internet Comcast will remain the dominant provider in many parts of the country and compete well in areas where the phone companies are building fiber. The high margins on internet access should offset the decline in the traditional television business, where margins have plunged in recent years.
According to Hodel’s observation, Comcast has managed NBCUniversal exceptionally well, more than doubling cash flow since the 2011 acquisition of the business through 2019, prior to the pandemic. The firm has invested aggressively in content, improving the performance of both the broadcast network and the movie studio. The TV business is evolving, which will present challenges for NBCUniversal, but Hodel believes it has the breadth of assets to effectively compete. The decision to merge the television business into a single unit was smart, in Hodel’s view, as it should allow NBCUniversal to make better content decisions and place programming on whichever platform—broadcast, cable, or the new Peacock service—will deliver the best returns. Adding Sky’s capabilities outside the U.S. should add to Comcast’s ability to distribute content.
The Ultimate Stock-Pickers’ Top 10 Stock Purchases list contained many names with moats that were distributed across a wide range of sectors, including basic materials, technology, financial services, energy, basic materials, communication services, and consumer cyclical. One company that stood out to us was Shopify SHOP, which was purchased by four Ultimate Stock-Pickers during the quarter.
Narrow-moat Shopify trades at a 30% discount to Dan Romanoff’s fair value estimate of $45. Shopify offers an e-commerce platform primarily to small- and mid-sized businesses. The firm has two segments: subscription solutions (43% of fiscal 2018 revenue) and merchant solutions (57% of fiscal 2018 revenue). The subscription solutions segment allows Shopify merchants to conduct e-commerce on a variety of platforms, including the company’s website, physical stores, pop-up stores, kiosks, social networks (Facebook), and Amazon. Merchant solutions are add-on products for the platform that facilitate e-commerce and include Shopify Payments, Shopify Shipping, and Shopify Capital.
Romanoff details that Shopify strives to be a one-stop shop for small retail businesses, especially those that are e-commerce primarily, only, or first. The company offers a simple but robust e-commerce platform with a variety of related add-on functionalities, including the Shopify Fulfillment Network, or SFN, that ultimately converge into a turnkey solution for small- and mid-sized businesses, or SMBs. Shopify’s rapid rise since its 2015 initial public offering underscores a nascent software niche that is rapidly growing and demonstrates a winning solution. He believes the company has established a narrow moat, as switching critical e-commerce platforms has financial and operational costs for an already resource-constrained SMB. Ultimately, Romanoff forecasts robust top-line growth benefiting from e-commerce trends over the next several years.
Romanoff’s research suggests Shopify is the leading platform for SMBs, as supported by the largest number of merchants of any platform. More merchants and high attach rates from add-on features like payments, SFN, and shipping should continue to drive strong revenue growth over the medium term. The company’s focus on using search engine optimization, topical blogs, and network referrals to attract SMB users suggests to us that there should be leverage in the sales and marketing line to help increase operating margins over time. Romanoff also thinks scale will help drive margins higher.
Ease of use, a large expert support community, and an emerging developer ecosystem combine to make Shopify’s platform attractive to users of all sizes, in Romanoff’s opinion. Add-ons such as payments, SFN, shipping, and capital allow for upsells and provide another growth lever for the company. After establishing itself as the SMB leader, Shopify has been pushing more into the enterprise with Shopify Plus, which allows online stores to remain on the platform as their needs become more advanced. Romanoff suggests that at the higher end, the company will enjoy some success, but it will face stiff competition from highly sophisticated and tightly integrated platforms from Salesforce.com and Adobe. With the build-out of the SFN, Romanoff sees the company increasingly competing with Amazon.
Much of the selling activity on the Ultimate Stock-Pickers' Top 10 Stock Sales list continued to come from the financial services sector this quarter, which contributed to five of the names on the list, up from four in the previous quarter. More than half the names on the conviction sales list traded at a notable discount to our fair value estimates, while two names (Progressive PGR and Marsh & McLennan Companies), were materially overvalued and one name (Texas Instruments TXN) was fairly valued. Of note this period was Visa V, which currently trades at a discount to Morningstar analyst Brett Horn’s fair value estimate of $229.
Visa is the largest payment processor in the world. In fiscal 2021, it processed over $10 trillion in purchase transactions. Visa operates in over 200 countries and processes transactions in over 160 currencies. Its systems are capable of processing over 65,000 transactions per second.
Horn believes Visa is a somewhat unique company in that it is a longtime, established market leader that still enjoys strong growth prospects. Despite the ongoing evolution of the payments industry, Horn thinks a wide moat surrounds the business and that Visa’s position in the global electronic payment infrastructure is essentially unassailable.
The shift toward electronic payments has driven Visa’s growth historically, and Horn expects that to continue for the foreseeable future. Digital payments, on a global basis, surpassed cash payments just a few years ago, suggesting this trend still has a lot of room to run. Horn thinks emerging markets could offer a further growth spurt even if momentum in developed markets slows. Visa’s position as the leading network makes it something of a tollbooth business, and the company is relatively agnostic to the smaller shifts within electronic payments, since it earns fees regardless of whether payment is credit, debit, or mobile.
Visa is not without its issues in the near term, and its smaller peer, Mastercard MA, has been performing better over the past few years, according to Horn. Cross-border transactions, which are particularly lucrative for the networks, saw dramatic declines due to the coronavirus outbreak and a reduction in global travel. He expects this headwind to endure for some time, but history suggests travel ultimately makes a full recovery following disruptive events and we expect that to be the case again, although the process could take a few years.
Horn notes that Visa obviously has sensitivity to the volume of consumer transactions, and the U.S. remains its largest market. A downturn in the economy would slow growth, and the fallout from the coronavirus has had a material impact, with both card networks seeing major declines in transaction volumes, although that pressure has started to reverse. However, Horn doesn’t see any long-term industry trends that will impede Visa’s ability to maintain its growth in the coming years, and the scalability of the business should still allow the company to modestly expand its already ample margins over time.
Disclosure: Ari Felhandler has an ownership interest in Microsoft. Rue Shetty and Eric Compton have no ownership interests in any of the securities mentioned above. It should also be noted that Morningstar's Institutional Equity Research Service offers research and analyst access to institutional asset managers. Through this service, Morningstar may have a business relationship with fund companies discussed in this report. Our business relationships in no way influence the funds or stocks discussed here.