Thesis
For the 1500 largest and most important companies in our 1,000-company universe, we give you our unbiased opinion on the stock's prospects. The Take is updated whenever conditions warrant, providing valuable commentary on a company’s success or failure, as well as long-term insights into the company’s strategic goals.
Our analysts cull information from every available source—SEC filings, company press releases, news services, and our own proprietary financial database—to provide insights on stocks that can’t be found anywhere else.
Valuation
An explanation of the Morningstar analyst's estimate of what the stock is worth. Our fair value estimate should be used in conjunction with our Economic Moat rating and our Business Risk rating.
Risk
To generate Morningstar Business Risk, analysts score companies based on the size of their economic moat, as well as an assessment of event risk, or the chance that a non-financial issue that could materially affect the company's fortunes. Based on these two factors, we classify the company's level of business risk as above average, average, below average, or speculative.
Strategy
A quick summary of the company’s future strategy, including plans for growing the business, improving financial performance, or dealing with major opportunities and challenges.
Management
Look for facts about management’s past experience, who’s in and who’s out, as well as the successes—and foibles—of significant executives.
Profile
This section provides a brief description of the company’s operations—major product lines, how and where it earns revenues, and any recent acquisition or spinoff activity.
Growth
A good history of growth can often signal strong future prospects.
Profitability
We judge profitability according to how well it uses its investors’ money (assets and stockholders’ equity) to generate profits.
Financial Health
We believe cash is king. We evaluate a company’s financial health according the strength of its balance sheet, especially in regard to how much cash it has, how much cash it generates … and where that cash goes.
The Morningstar Rating for Stocks is calculated by comparing a stock's current market price with Morningstar's estimate of the stock's fair value. Our rating system also includes an uncertainty adjustment, so that it's more difficult for a company to earn a 5-star rating the more uncertain we are of our fair value estimate.
Under our system, 3-star stocks are those that should offer a "fair return," one that adequately compensates for the riskiness of the stock. Three-star stocks should offer investors a return that's roughly comparable to the stock's cost of equity. (The cost of equity is often called a "required return" because it represents the return an investor requires for taking on the risk of owning the stock.)
Five-star stocks, of course, should offer an investor a return that's well above the company's cost of equity. Conversely, low-rated stocks have significantly lower expected returns.
The Morningstar Rating for Stocks also includes a small buffer around the cutoff between each rating, to reduce the number of rating changes produced by random market "noise." If a $50 stock moves up and down by $0.25 each day over a few days, the buffer will prevent the star rating from changing each day based on this insignificant change.
Fair Value Estimate
The Morningstar analyst's estimate of what the stock is worth. Our fair value estimate should be used in conjunction with our Economic Moat rating and our Business Risk rating.
To generate the Fair Value Uncertainty Rating, analysts consider factors such as sales predictability, operating leverage, financial leverage, and a firm’s exposure to contingent events. Analysts then classify stocks into one of several uncertainty levels: Low, Medium, High, Very High, or Extreme. The greater the level of uncertainty, the greater the discount to fair value required before a stock can earn 5 stars, and the greater the premium to fair value before a stock earns a 1-star rating.
The idea of an economic moat refers to how likely companies are to keep competitors at bay for an extended period. One of the keys to finding superior long-term investments is buying companies that will be able to stay one step ahead of their competitors, and it's this characteristic—think of it as the strength and sustainability of a firm's competitive advantage—what we're trying to capture with the economic moat rating.
One of the first things we do when we're thinking about the size of a firm's economic moat is look at the company's historical financial performance. Companies that have generated returns on capital higher than their cost of capital for many years running are usually have a moat, especially if their returns on capital have been rising or are fairly stable.
Of course, the past is a highly imperfect predictor of the future, so we look carefully at the source of a company's excess economic profits before assigning a moat rating. For example, a competitive advantage created by a hot new technology usually isn't very sustainable, because it won't be too long until someone comes along and invents a better widget.
Here are some of the attributes that can give companies economic moats:
Huge Market Share: When a firm enjoys economies of scale in areas like manufacturing, sales, and marketing, it can be pretty tough for a competitor to catch up.
Low-Cost Producer: The ability to produce products or services at a lower cost than competitors is an advantage that's especially potent in commodity industries.
Patents, Copyrights, or Governmental Approvals and Licenses: Some companies generate enormous profits when their products or markets are artificially protected by the government.
Unique Corporate Culture: Although you should be careful of placing too much emphasis on this attribute, since it's such a "soft" method of determining competitive advantage, there's no question it can make a difference.
High Customer-Switching Costs: If you can make it tough for your customers to use a competitor, it's usually easy to keep ratcheting prices up just a bit year after year--which can lead to big profits.
The Network Effect: This is a relatively rare, but potentially quite potent, source of competitive advantage, and often accrues by the first mover in an emerging technology. Since a network's value increases as more people use it, the company that creates the network can create a massive economic moat.
Bulls Say
These are the most important arguments about the company in favor of owning its stock.
Bears Say
These are the most important arguments about the company against owning its stock.
A Note About Morningstar's Editorial Policies:
It is core to Morningstar's culture to put the investor first, which means we follow a set of rules designed to maintain the independence and objectivity of our analysts.
Business Relationships
At any given time, Morningstar has licensing, advertising, and sponsorship relationships with a number of publicly traded companies. As of September, 2004, these include firms such as American Express, Ameritrade, Charles Schwab, Citigroup, E*Trade, Fidelity, John Wiley & Sons, J.P. Morgan Chase, Merrill Lynch, Morgan Stanley, Northern Trust, T. Rowe Price, and Vanguard.
Restricted List
To avoid conflicts of interest, Morningstar maintains the following policies on employee stock ownership. These policies apply to employees and their immediate family members.
We prohibit any Morningstar employee from owning shares in a mutual-fund company. That includes firms like T. Rowe Price, Eaton Vance, Gabelli Asset Management, and any other firm that receives at least 20% of its revenues from mutual funds, separate accounts, and the like.
We prohibit equity analysts from holding positions in the companies they cover, or the close competitors of companies they cover.
To ensure that our customers are the first to benefit from our research, whenever an equity analyst begins researching a stock, we put it on our restricted list. Any stock on this list is off-limits to all Morningstar employees and their immediate families. The stock remains on the restricted list until five business days after we publish the report.
No Morningstar restrictions apply to conventional open-end mutual funds. Because these funds aren't sold on exchanges, trading by those with access to special information can't affect the funds' prices.
Disclosure of Ownership
If an analyst owns a stock they're writing about, we disclose that fact at the bottom of any editorial piece that mentions the security.