Investment Strategy

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Investment Strategy
What is the goal of the Tortoise Portfolio? The Tortoise Portfolio aims to outperform the S&P 500 index over time. Companies in this portfolio tend to be mature, relatively slow-growing, and with moderate to low risk. New purchases must have an economic moat, preferably wide. We attempt to tilt the portfolio toward companies with at least stable competitive advantages (stable moat trends).

What is the goal of the Hare Portfolio? The Hare Portfolio aims to outperform the S&P 500 index over time. Companies in this portfolio tend to be faster-growing, with both higher risk and higher return potential than those in the Tortoise. New purchases must have an economic moat, preferably wide. We attempt to tilt the portfolio toward companies with growing competitive advantages (positive moat trends).

Investment Strategy
Morningstar StockInvestor invests in companies with established competitive advantages and generous free cash flows, trading at discounts to their intrinsic values. These are core holdings, with more conservative ideas appearing in the Tortoise Portfolio and more aggressive ideas in the Hare Portfolio. We expect both portfolios to beat broad U.S. stock index benchmarks, such as the S&P 500, over rolling three-year periods.
About the Editor
As editor of Morningstar's StockInvestor newsletter, Matthew Coffina manages the publication's two real-money, market-beating model portfolios — the Tortoise and the Hare. Matt was previously a senior healthcare analyst, covering managed care and pharmaceutical services companies. Matt also developed the discounted cash flow model used by Morningstar analysts to assign fair value estimates to most of the companies in its global coverage universe.

Matt joined Morningstar in 2007. He holds a bachelor's degree in economics from Oberlin College and also holds the Chartered Financial Analyst (CFA) designation.

Nov 24, 2015
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Matthew Coffina, CFA
Morningstar StockInvestor
As editor of Morningstar's StockInvestor newsletter, Matthew Coffina manages the publication's two real-money, market-beating model portfolios -- the Tortoise and the Hare. Matt was previously a senior healthcare analyst, covering managed care and
Featured Posts
Roundup, 11/20/15 -- Another Strong Quarter from Lowe's

At a time when many retailers are struggling, the home improvement chains continue to shine. In its latest quarterly report, Lowe's LOW delivered 4.6% same-store sales growth, while earnings per share soared nearly 36% thanks to a combination of operating margin expansion and share repurchases. Although Home Depot HD continues to grow same-store sales at a faster pace than Lowe's, I believe Lowe's has more room to expand margins, which remain below pre-housing-crash norms. At the same time, Lowe's same-store sales growth is very good in an absolute sense, reinforcing our thesis that home improvement retailers are well insulated from competitive and e-commerce threats. We raised our fair value estimate to $79 from $74 to incorporate recent cash flows. While I trimmed our stake in Lowe's earlier this week for diversification reasons, it remains the Tortoise's second-largest position and a core long-term holding.

Elsewhere, Ctrip CTRP reported strong quarterly results, and its operating margins already seem to be benefiting from the recent consolidation of China's online travel agency business. This is modestly positive for Hare holdings Baidu BIDU and Priceline PCLN, which are among Ctrip's biggest shareholders.


Matt Coffina, CFA
Editor, Morningstar StockInvestor


Disclosure: I own all of the stocks in the Tortoise and Hare in my personal portfolio.


Morningstar Stock Analyst Notes

Lowe's LOW  |  Jaime M. Katz, CFA

Lowe's continues to perpetuate operating margin improvement through better merchandising and expense leverage, following suit of peer Home Depot. While quarterly comps have trailed its closest competitor over the past five years, we still think performance has been very consistent, and on an absolute basis has outperformed numerous other brick-and-mortar retailers by a landslide, supporting our view that home improvement is one of the more defensible business models in the retail space today. We plan to raise our $74 fair value estimate modestly in response to cash earned since our last report, and we believe that Lowe's can capture faster operating margin expansion than Home Depot over the next three years (2015-17), but that ultimately this margin improvement converges on a normalized pace, at 30-40 basis points annually. At current levels, shares will be modestly undervalued to our updated fair value estimate, and we believe there could be an opportunity to enter shares if they dip around 5% from current levels, and enter 4-star territory.

Lowe’s proprietary consumer sentiment survey (which indicated the desire to invest in the home continues to grow), along with metrics such as home prices and disposable personal income, have kept management’s outlook positive for 2015, and thus the firm has maintained its full-year guidance. Our prior fiscal 2016 forecast included earnings per share of $3.28, comp sales of 4.5% and revenue growth of 4.7%, none of which we expect to change meaningfully. Morningstar's outlook for the repair and remodel market runs at a mid-single-digit pace through 2020, which our model incorporates. We still fall a bit below firm expectations for 11% operating margins in 2017; we view 80 basis points of annual expansion achievable on average, but largely contingent on precise execution and a continued upswing in willingness to spend, on which timing could have an impact. We have 70 basis points of expansion in each of the forward two years.

In the quarter total sales rose 5% to 14.4 billion, helped by comparable sales growth 4.6% (2.5% increase in comp transactions and 2% increase in average ticket) and geographically diverse solid performance (all 14 US regions generated positive comps and Canada and Mexico delivered high single digit comps in local currency). Operational improvement continues to tick up, with gross margins rising nearly 30 basis points benefiting from improved sell through of seasonal products and product cost deflation, and SG&A leveraging more than 90 basis points, to 22.9%, as more efficient advertising, benefits from the credit program, lower building maintenance and repair costs and strategic deployment of labor (store payroll) helped about equally in the period. In our opinion, Lowe’s can continue to pull on multiple levers over the next few years to continue to drive cost improvement, ultimately leading to operating margins of nearly 13%, which is still marginally lower than our long term outlook for Home Depot operating margin levels (of about 16%).

Running in parallel with Home Depot, Lowe’s opportunities lie within Professional growth and omnichannel improvements, and we still believe the industry is big enough and both businesses are leaders by a wide enough margin to both benefit from similar efforts. Over the past year-plus, Lowe’s has focused on the project side of its professional business, and in the most recent period added its interior specialists program to 475 new locations (in total at 1,365 stores) with representation for exterior specialists at all U.S. locations. These professionals will help Lowe’s gain brand equity as consumers facilitate their renovations from start to finish through Lowe’s but also offers additional insight to field based merchandising managers that work with the professionals to better supply local market with relevant SKUs. This, ultimately, should better match supply and demand in regional marketplaces to drive sustainable improvement in the gross margin over the next few years at a minimum.


Baidu BIDU  |  Marie Sun

Ctrip reported strong revenue growth of 49.4% year on year in the third quarter, which is towards the upper end of company guidance. Outbound travel and leisure travel are the key growth drivers. The international hotel segment has seen triple-digit growth in the third quarter and accounts for 10%-15% of total accommodation reservation revenues. International air ticketing revenue increased by 100% year on year and accounted for 25%-30% of total air ticketing revenue, with international destinations contributing 60% of revenue from packaged tours. The company guided for continued strong growth of 45%-50% in the fourth quarter. We believe Ctrip’s economic moat has been strengthened after the tie-up with eLong and Qunar, and it is the best-positioned online travel company in China for overseas market expansion, given its partnerships with international online travel leaders Priceline and Expedia. We have increased our fair value estimate for narrow-moat Ctrip to $106 per ADR to reflect margin recovery after its merger with eLong and Qunar and the equity method income/loss from eLong and Qunar. Wide-moat Baidu, Ctrip’s largest shareholder (holding a 25% stake), should also benefit from Ctrip’s strengthening market position and improved profitability.

Ctrip’s margins improved significantly in the third quarter as a result of decreased competition after market consolidation. The gross margin improved by 230 basis points, and the non-GAAP operating margin increased to 17%, versus 8.5% in the second quarter and 10.6% in the year-ago period. After combining eLong and Qunar, Ctrip becomes the largest online travel company in China and can focus more on improving the efficiency of its operations. We believe the synergy of the combination is obvious. Since the company acquired a 37.6% stake in eLong and became the largest shareholder, it has seen a decrease in hotel coupons as a percentage of total accommodation reservation revenue, to 17% from 20%-21% in second-half 2014. The merger with Qunar has resulted in less low-priced competition and has increased its consumer base, although we think the full integration still needs time. Ctrip targeted the mid- to high-end market, while Qunar had younger consumers with more price sensitivity. Moreover, Ctrip will benefit from Baidu’s large Internet ecosystem, including traffic from Baidu Map, Mobile Baidu Search and O2O platforms, after Baidu became the largest shareholder as a result of the Qunar deal.

We believe the near- to midterm growth driver is outbound travel and leisure travel, and Ctrip is competing with Tongcheng and Tuniu. Tongcheng is growing fast with its distinctive business selling discounted tickets to scenic spots, and Tuniu has more than 66% sales from outbound travel. Ctrip has a minority stake in both companies, while Tencent and Tencent-related companies have also invested in both. Since small players in online travel still can’t reach a break-even point, we believe there will be further market consolidation.

Ctrip announced that it would change the ratio of its ADRs to ordinary shares, from four ADRs representing one ordinary share to eight, effective December.


Priceline PCLN  |  Dan Wasiolek

Since August 2014, narrow-moat Priceline has invested $1.3 billion in Ctrip stock and convertible notes that we estimate equals a 15% ownership stake, worth $2.3 billion at recent prices. While adding the incremental $1 billion gain (a roughly 75% return) into our Priceline model would increase our $1,830 fair value estimate only 1.4%, we think Ctrip's leading position in the online China travel market is intact, leading to increased confidence in our projection for Ctrip's revenue as percentage of Priceline's total to grow to midsingle digits in 2019 from low single digits currently. In addition, Priceline is well positioned for the ongoing strength in outbound online Chinese travel, as most of its outbound business is done outside Ctrip (organic growth and other domestic relationships). We maintain our $1,830 fair value estimate for Priceline and continue to recommend investment.

Ctrip's third-quarter sales growth of 49% supports our view that Ctrip is a long-term winner in the China online travel market, which we expect to grow more than 20% annually for the next few years (representing a high teens percentage of total online travel industry growth). Additionally, Ctrip's third-quarter operating margins were 13% compared with 4% a year ago, as recent relationships with Qunar and eLong appear to be driving operational synergies and a more rational domestic competitive environment. This is further evidence of the company's strong position in the industry.

While negligible near term, Expedia stands to benefit long term through its eLong and Ctrip collaboration for outbound travel services (terms unknown). Our view is that Priceline's relationship to provide outbound accommodations on Ctrip's platform is intact, as the two companies have been in a partnership since 2012. Priceline has rights to one Ctrip board seat as well as its 15% equity stake, which includes convertible notes.


Berkshire Hathaway BRK.B  |  Greggory Warren, CFA

While wide-moat Berkshire Hathaway's third-quarter 13-F filing offered some insight into the changes made to the insurer's common stock holdings during the period, these actions were overshadowed by the closing of the Kraft Heinz deal in early July and the announcement that Berkshire would buy Precision Castparts outright in early August. By merging its Heinz stake into Kraft Foods, CEO Warren Buffett has turned Kraft Heinz into the company's second-largest stock holding at 18% of the reported portfolio, with Wells Fargo continuing to hold the top spot at 19%. While the purchase of Precision Castparts will represent an even larger capital commitment than Buffett has made to either Wells Fargo or Kraft Heinz, it currently represents less than 1% of the total portfolio. The $32.4 billion deal is expected to close during the first quarter of 2016, at which time it will no longer be reported as a stock holding.

Looking more closely at the third-quarter purchases, Berkshire picked up 54 million additional shares in Phillips 66, which we had highlighted in late August. Our take then was that it looked like Berkshire was in a buying mood, even after Buffett had committed more than $20 billion in cash to the Precision Castparts deal. Some of the other more notable purchases made during the quarter included increased stakes in Charter Communications, General Motors, Suncor Energy, and Axalta Coating Systems. The new holding in AT&T should not be viewed as a purchase as it was the direct result of that firm's acquisition of DirecTV.

Berkshire eliminated its stake in Viacom, significantly reduced its holdings in Chicago Bridge & Iron, and sold off shares of Goldman Sachs and Wal-Mart. The last sales were made to raise capital for the Precision Castparts deal, allowing Buffett to keep more dry powder on hand should any other potential investments (including buying back Berkshire's shares) present themselves in the near term.

Given all of the transactions, as well as the unrealized gains/losses, that occurred during the quarter, the makeup of Berkshire's top five stock holdings--Wells Fargo (19%), Kraft Heinz (18%), Coca-Cola (13%), IBM (9%), and American Express (9%)--has shifted some. The ascension of Kraft Heinz has pushed Wal-Mart out of the top five, aided by the latter company's poor stock performance and the sale of 7% of Berkshire's holdings in the retail giant during the period.


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