Today’s Daily Alert comes from your new Investment Digest, which you’ll receive this afternoon. The recommendation is an ETF based on the concept of economic moats, as described below by The Cash Cow Editor Steven Lord.
“The schizophrenic trading of the past several months has raised the stature of companies that have strong, defendable businesses. These are firms with a combination of market share, unique technology, intellectual property, good execution, balance sheet strength and cycle-resistant products that form an economic ‘moat’ around their businesses. ... They may not be the fastest-growing stocks on your screen, but businesses able to maintain (or even widen) their economic moat during a downturn are less volatile and, more consistent investments over the long haul. ... Being on top does not mean your business has a moat around it — you need solid, sustainable competitive advantages to protect against becoming an also-ran in a few short years.
“The current market environment lends itself to companies with wide moats, since investors can have some faith that wide-moat business models will be able to withstand pressure better than most. In theory, a portfolio of wide-moat stocks should be more stable and of higher quality than one made up of higher growth but ultimately more vulnerable names. Moreover, a wide-moat company will be considered a safer haven than those without one, which can result in a premium valuation during periods of market stress.
“For several years, the research firm Morningstar has included moats in their assessment of a stock, not only in terms of whether a moat exists around a business but also how entrenched/wide it is and how a company’s valuation is enhanced by it. In fact, the company has created an index, the Morningstar Wide Moat Focus Index, which is comprised of the 20 most attractively priced wide-moat companies as defined by Morningstar. [And] the index has done very well, outperforming the S&P 500 by several hundred basis points since 2002 though the first quarter of this year, although it has been more volatile in recent years. And as you might expect, there is an ETF tracking it.
“The recently launched Market Vectors Morningstar Wide Moat Research ETF (MOAT) replicates Morningstar’s moat-oriented index. The 20 stocks are virtually all large-cap, familiar names — Amazon.com, Northern Trust, Compass Minerals, Pfizer, Merck, Bank of New York, General Electric, etc. Position weightings generally run between 4.5% and 6.22%, with 52.5% of assets in the top ten holdings (and 17% in the top three). Information technology comprises one-quarter of the group, followed by financial services companies at 20%, health-care and materials at 15% apiece and industrial firms at 10 percent. Interestingly, energy, real estate and utility companies make less than 5 percent of the ETF’s portfolio, which is almost exclusively U.S. in origin.
“Because the index is rebalanced quarterly and the stocks with the highest difference between Morningstar’s fair value calculation and current stock price are chosen, MOAT has a bit of a value orientation. This means most of the securities in it are trading for valuation levels below their historical norms and are thus undervalued. At the same time, they are usually very high quality — nine of the 20 positions are rated five stars by Morningstar and a further nine four stars — if perhaps less dynamic on the growth front.
“MOAT is a new fund, having launched only in April of 2012. Since then, the fund has attracted $23 million in assets, which, while not a record setter, is a highly respectable number nonetheless (especially given what has been going on in equities since then). In the meantime, the new fund trades a respectable 58,000 shares per day, and may ultimately pay as much as 2.5% in dividends over the course of a year.
“It is a bit more volatile than we’d like, reaching $21 immediately after launch. Having swooned to under $19, the real bet here is that the things that endear MOAT’s constituents are not going away anytime soon. We like MOAT’s heavily recession-resistant characteristics and believe over time, this fund’s strategy will pay off in droves. We’re adding MOAT to our recommended list at current levels just under $19.”
- Steven Lord, Stephen Leeb’s The Cash Cow, July 2012