Moat Investing: Don’t Ignore Valuations

By Coulter Regal, CFA
Associate Product Manager

The Morningstar Wide Moat Focus Index remains ahead of the S&P 500 year-to-date, though was not immune to September’s turbulence, performing in line with the S&P 500 for the month.

The September Effect, referring to the historically weak stock market returns observed during the month, once again proved statistically significant. Negative sentiment and volatility plagued the U.S. equity markets this September, leading to sizeable declines in the U.S. equity market and fresh lows for the S&P 500® Index.

The Morningstar® Wide Moat Focus IndexSM (the “Moat Index” or “Index”) was not immune to the turbulence this month and mainly performed in line with the S&P 500 Index (-9.90% vs. -9.16%, respectively). However, year–to–date the Moat Index maintains its outperformance (-20.82% vs. -23.87%, respectively) as of September 30, 2022.

Valuations: An Important Consideration

During volatile periods in the market, oftentimes, investors will look to seek shelter in companies that exhibit a quality factor tilt with the expectation that they will prove more resilient. Screening for quality companies, or the frequently equated wide moat companies, is undoubtedly an important consideration; however, it should not be the only one.

The quality factor, represented by the Russell 1000 Quality Factor Index, has actually underperformed the S&P 500 Index this year by roughly 200 basis points as of September. The story is similar when looking at an index of just wide moat companies with no consideration for valuations. While the expectation is that these quality companies will outperform in the long–run, if history repeats, recent underperformance highlights the importance of looking at more than just quality.

Surprisingly, U.S. companies that Morningstar analysts deem “moatless” (i.e., lacking a competitive advantage or possessing a fleeting advantage) have actually outperformed their wide moat peers through the first nine months of 2022.

Index Companies Return (%)
Moat Index Select U.S. wide moat companies with attractive valuations -20.82
Morningstar Wide Moat Index All U.S. wide moats companies, market cap weighted -27.61
Russell 1000 Quality Index U.S. large cap companies with “quality” characteristics -25.91
Morningstar No Moat Index All U.S. no moat companies, market cap weighted -25.83
S&P 500 Index Largest U.S. companies -23.87

Source: Morningstar.

Layering a valuation–based selection screen on top of the universe of wide moat companies is how the Moat Index sets itself apart in various market environments. According to Morningstar, the performance of the Moat Index, which targets the wide moat stocks trading at the greatest discounts to fair value, helps illustrate this. The Moat index has outperformed various proxies for quality by 500 basis points or more so far this year.

Key Takeaways from the Moat Index’s Q3 Review

The Moat Index underwent its regularly scheduled quarterly review on September 16, 2022. Below are a few key takeaways from the review.

Index Valuation Remains Near Five–Year Lows

As of September 30, 2022, the reconstituted Moat Index exhibited a weighted average Price/Fair Value ratio (“P/FV”) of 0.66, signaling a roughly 34% discount to Morningstar’s assessment of fair value. This is in contrast to the S&P 500 Index, which featured a weighted average P/FV ratio of 0.85 for the same date. For context, the Morningstar Wide Moat Index’s five–year average P/FV was 0.87, and S&P 500 Index’s was 1.03, and they dropped as low as 0.62 and 0.77 over the last five years, respectively, in March 2020.

Style Exposure and Sector Shifts

Similar to both the March and June reviews, the Index’s growth style exposure again saw an increase representing valuation opportunities among wide moat growth stocks following the volatility of the past several months. The increase in growth exposure was largely at the expense of value, which declined for the third time this year. Style exposure in the Moat Index is now the closest to the S&P 500 Index’s in quite some time.

Style Current Exposure Rebalance Change Relative to S&P 500
Value 28.4% -2.8% +5.1%
Core 39.7% -1.0% +1.1%
Growth 31.9% +3.8% -5.9%

Source: Morningstar. As of 9/16/2022.

From a sector perspective, following the removal of several consumer staples names (Kellogg, Philip Morris, and Campbell Soup Co), the sector is now the largest underweight relative to the S&P 500. The greatest overweight remains the industrials sector. Technology stocks continue to represent an increasingly large portion of the Moat Index and are now nearly 5% overweight the S&P 500 Index; 4 of the 10 additions at this quarterly reconstitution were tech stocks.

Moat Downgrade Removes Intel

Changes to a company’s moat rating are not a common event. The competitive advantages required to obtain a wide moat rating within Morningstar’s framework are difficult to obtain and durable in nature. However, despite being generally sticky, moat ratings can and do change on occasion.

This quarter’s reconstitution of the Moat Index saw the moat downgrade and thus the removal of Intel. Intel’s downgrade is the first to impact the Index since December 2021, when Cerner was last removed following its downgrade. Morningstar’s reasoning for Intel’s downgrade is noted below.

Morningstar Commentary – July 29, 2022:

“We are lowering our moat rating for Intel to narrow from wide, as we are no longer certain that the firm can generate excess returns on capital over the next few years. We still believe Intel possesses cost advantages realized in the design and manufacturing of its cutting–edge microprocessors and intangible assets related to its x86 instruction set architecture license and chip design expertise. However, we believe Intel’s cost advantage has eroded, as it faced significant product delays associated with its various 10–nanometer process technologies. Intel’s x86 rival, AMD, and its foundry partner, Taiwan Semiconductor Manufacturing, or TSMC, have combined to leapfrog Intel in cutting–edge processors. In turn, in recent years, Intel has lost market share, conceded on pricing, and faced a sharp decline in gross margins and returns on invested capital. We believe that it is more likely than not that Intel can close the gap with TSMC/AMD and generate excess returns on capital over the next decade, but this is no longer a certainty, and we concede that Intel’s manufacturing inferiority to TSMC/AMD will persist for the next year or two and perhaps longer.”

View the full results of the most recent quarterly review here.

VanEck Morningstar Wide ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.

Originally published by VanEck on October 6, 2022. 

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Important Disclosures

Source for all data unless otherwise noted: Morningstar.

Fair value estimate: the Morningstar analyst’s estimate of what a stock is worth. Price/Fair Value: ratio of a stock’s trading price to its fair value estimate.

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The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its employees.

This commentary is not intended as a recommendation to buy or to sell any of the sectors or securities mentioned herein. Holdings will vary for the MOAT ETF and its corresponding Index. For a complete list of holdings in the ETF, please click here:

An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses, nor does the Index lend securities, and no revenues from securities lending were added to the performance shown.

The Morningstar® Wide Moat Focus IndexSM was created and is maintained by Morningstar, Inc. Morningstar, Inc. does not sponsor, endorse, issue, sell, or promote the VanEck Morningstar Wide Moat ETF and bears no liability with respect to that ETF or any security. Morningstar® is a registered trademark of Morningstar, Inc. Morningstar® Wide Moat Focus IndexSM is a service mark of Morningstar, Inc.

Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover, and longer holding periods for index constituents than under the rules in effect prior to this date. Past performance is no guarantee of future results.

The Morningstar moat–driven indexes represent various regional exposures and consist of companies identified as having sustainable, competitive advantages and whose stocks are attractively priced, according to Morningstar.

The S&P 500® Index consists of 500 widely held common stocks covering industrial, utility, financial and transportation sector; as an Index, it is unmanaged and is not a security in which investments can be made.

Morningstar® US Wide Moat Composite IndexSM: The index is a float market cap weighted index of all securities in the Morningstar US Market Index with a ‘Wide Moat’ rating.

Russell 1000 Quality Factor Index: The index delivers exposure to companies in the Russell 1000 that exhibit common characteristics associated with the quality factor.

Morningstar No Moat Index: The index is a float market cap weighted index of all securities in the Morningstar US Market Index with a ‘no moat’ rating

Morningstar® US Market IndexSM: The index covers the top 97% of market capitalization of the U.S. equity markets.

The S&P 500® Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2021 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

An investment in the VanEck Morningstar Wide Moat ETF (MOAT®) may be subject to risks which include, among others, investing in equity securities, consumer discretionary, consumer staples, health care, industrials and information technology sectors, medium–capitalization companies, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non–diversification and concentration risks, which may make these investments volatile in price or difficult to trade. Medium–capitalization companies may be subject to elevated risks.

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