We Just Downgraded These 2 Stocks. Is It Time to Sell?

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. When investing, we think it’s important to understand a company’s competitive advantages. Morningstar encapsulates a company’s competitive advantages in our economic moat ratings. We expect companies that earn wide economic moat ratings to be able to fight off competitors for 20 years or more; companies that earn narrow economic moat ratings, we expect those to be competitive for the next decade or longer. Now, a company can carve out these competitive advantages a few different ways. Some companies have patents or brands that give them an edge. Others may have a cost advantage, or pricing power.

A company’s economic moat rating isn’t carved in stone; economic moats can strengthen, or they can erode over time as companies and sometimes entire industries evolve. But just because we’ve downgraded a company’s economic moat doesn’t mean investors should sell the company’s stock. The stocks of companies that have experienced downgrades can still be undervalued, depending on where the stock is trading relative to our fair value estimate. Put another way, a downgraded company may in fact be a stock-buying opportunity.

Today we’re looking at two companies whose economic moat ratings we recently downgraded. Yet despite the downgrades, the stocks of these companies look like undervalued opportunities for long-term investors.

We Just Downgraded These 2 Stocks. Is It Time to Sell?

1. Paramount Global PARA
2. Warner Bros. Discovery WBD

Morningstar downgraded the economic moat ratings on Paramount Global and Warner Bros. Discovery from narrow to none. We think these two names in the entertainment industry are similar, in that they’re both finding their way in the evolving media landscape. We expect both to be survivors due to their scale, distribution channels, production studios, and content portfolios. But in today’s environment which is defined by cord-cutting and numerous choices for streaming, both companies face significantly more uncertainty than they have in the recent past.

For instance, cord-cutting and diminished linear television viewership have depressed carriage fees and advertising revenue. Less emphasis on movie theaters and an industry shift toward streaming services have depressed their licensing revenue.

Warner’s streaming business is now profitable and more mature than Paramount’s, and we think Warner has the right strategy to navigate the convergence between traditional and new media. But Paramount’s streaming service has also recently evolved, and we think it’s on the right track. Paramount has blurred the line between linear and streaming and moved to focus on one streaming platform for all of its best content.

The stocks of both Paramount Global and Warner Bros. Discovery look significantly undervalued to us today.

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Morningstar senior analyst Matthew Dolgin provided the research behind this segment.

Watch 3 Undervalued Stocks to Buy Before the Big Game for more from Susan Dziubinski.