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About the Editor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios invested in accordance with a strategy that seeks to focus on companies with stable or growing competitive advantages. David served in several senior research and product development roles and was part of the editorial team that created and launched Morningstar.com. He was the co-inventor of Morningstar's first investment advice software.

David joined Morningstar in 1994. He holds a bachelor's degree in biology from Skidmore College and a master's degree in biology from the University of Illinois at Springfield.

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Matthew Coffina, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Hare strategy. 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.

Michael Corty, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Tortoise strategy. Before focusing his attention on the Tortoise, Michael co-managed five equity strategies offered by Morningstar Investment Management LLC and Morningstar Investment Services LLC since December 2013. Michael was previously a senior equity analyst on Morningstar Inc.’s equity research team covering companies in the media, business services, and consumer industries. Michael also spent several years on Morningstar’s moat committee, which assigns economic moat and moat trend ratings to their global coverage.

Prior to joining Morningstar in 2004, Michael worked at a public accounting firm and in the business lending arm of a major commercial bank. He has an undergraduate accounting degree from Loyola Marymount University, an MBA from Cornell University and is a CFA charterholder.

 
Jan 22, 2017
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About the Editor David Photo
David Harrell
Editor, Morningstar StockInvestor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios
Featured Posts
Roundup 1/20/2017 -- A New Deal for Berkshire, Wells Fargo Still Undervalued

StockInvestorSM focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, which manages other client portfolios using these strategies.

Please see new analyst notes below for American Express AXP, Bank of New York Mellon BK, Berkshire Hathaway BRK.B, BlackRock BLK, General Electric GE, and Wells Fargo WFC.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

Modest Growth and Higher Spending Seem Likely to Persist at American Express
by Jim Sinegal | 01-19-17

American Express reported fourth-quarter earnings of $0.88, down just $0.01 from the fourth quarter of 2015, despite the loss of a large partnership with Costco, as the company benefited from the absence of a large impairment charge in the fourth quarter of 2015 and 7% decline in share count. American Express returned 138% of capital generated during the quarter. The company expects 2017 EPS of $5.60 to $5.80, implying a price/earnings multiple of 13 to 14 at our $76 fair value estimate. We’d like to see more evidence that the wide moat company is continuing to differentiate its offerings in a changing competitive environment before getting more bullish on its growth prospects. Indeed, the company’s top-line growth estimates seem relatively modest given the tailwind of electronic spending growth. This year, global billings grew by 7% excluding the loss of the Costco business, while U.S. business expanded by 6%.

Adjusted rewards spending grew by 13% as the firm introduced higher rewards in an increasingly competitive environment. The company also added $407 million in marketing and promotional spending. We remain concerned that top-line pressure will continue as OptBlue offers lower rates to merchants and tighter regulation of competitors' interchange fees produces indirect pressure. The extremely competitive rewards environment may be an even bigger problem. We believe that monoline firms like American Express are finally feeling the impact of card industry consolidation that occurred prior to the financial crisis--competitors like JPMorgan can bid for card issuing business with the knowledge that many customers may eventually provide additional revenue as relationships deepen.

Management did indicate that the corporate card business and its international businesses are not suffering to the same degree, which makes sense as the firm provides a more unique value proposition to businesses and foreign issuing banks.

BNY Mellon's 4Q Aided by Improved Net Interest Margin and Fees
by Greggory Warren, CFA | 01-19-17

There was little in wide-moat BNY Mellon's fourth-quarter results that would alter our long-term view of the firm. We are leaving our $49 per share fair value estimate in place. Net interest margin of 1.17% was an improvement on the third quarter of 2016 (1.06%), as well as the fourth quarter of 2015 (0.99%). Lower money market fee waivers also contributed to overall results, with waivers falling from $23 million in the year-ago period to less than $10 million during the fourth quarter.

Assets under custody/administration increased 3.5% year over year to $29.9 trillion, but were down 2.0% from $30.5 trillion at the end of the third quarter of 2016. BNY Mellon had $1.6 trillion directly under management at the end of the fourth quarter, with market gains and flows offsetting the effect of adverse currency, leaving AUM up just 1.4% year over year.

Fee revenue increased 0.5% when compared with the prior year's period, as higher investment services fees were offset by lower performance fees and other income. For the full year, fee revenue was basically flat at $12.0 billion. Total fourth-quarter revenue increased 1.7% to $3.8 billion, leaving full-year revenue at $15.2 billion, reflective of a 0.3% gain. Effective cost controls led to a 2.3% and 2.6% decline in noninterest expense during the fourth quarter and full year, respectively, allowing the firm to post fourth-quarter and full-year earnings per share of $0.77 and $3.15, compared with $0.57 and $2.71 during 2015.

Berkshire Hathaway's $9.8 Billion Reinsurance Deal With AIG Will Boost Premiums and Float
by Greggory Warren, CFA | 01-20-17

In a positive bit of news for wide-moat-rated Berkshire Hathaway's reinsurance operations, which continue to be negatively affected by a reinsurance market that has too much capacity (with pricing inadequate for the risks being assumed), the firm announced a major deal with AIG to assume the risks associated with certain U.S. commercial policies written by the latter firm prior to 2016. The $9.8 billion consideration for this agreement is payable in full by the end of June 2017, with AIG agreeing to pay interest (at a 4% annual rate) on any unpaid balance between the start of January 2017 and the actual payment date. The deal covers 80% of AIG's U.S. commercial long-tail exposures--primarily U.S. casualty exposures (likely tied to workers' compensation and environmental claims)--underwritten prior to 2016. We think this is a good bit of business for Berkshire, which has relied on Ajit Jain's expertise in risk assessment and underwriting for the past three decades to generate reinsurance deals that are priced appropriately for the level of risk that the firm is undertaking. In this instance, Berkshire will be covering 80% of the losses in excess of $25 billion for AIG's long-tail commercial exposures, with Berkshire's overall liability under the agreement limited to $20 billion. While the premiums associated with this contract will be earned over time (potentially lifting our forecast earned premium growth over the next five years), Berkshire will have the float associated with the deal available to invest as soon as it receives the payment from AIG. With interest rates expected to continue to rise, this could be a timely transaction for Berkshire. For the time being, though, we're leaving our fair value estimate for the firm in place but will adjust it in the near term if we feel that this deal (or other potential developments like corporate tax reform) affect our valuation in a material way.

Market Gains and Index Fund and ETF Flows Lift BlackRock's 4Q AUM
by Greggory Warren, CFA | 01-13-17

There was little in wide-moat-rated BlackRock's fourth-quarter results that would alter our long-term view of the firm. We are leaving our $385 per share fair value estimate in place. BlackRock closed out the December quarter with a record $5.148 trillion in managed assets (which was around $70 billion lower than our own forecast for the period, with most of the difference due to a greater level of adverse currency exchange than we were projecting). This represented a 0.6% sequential (and a 10.8% year-over-year improvement) in BlackRock's AUM.

Long-term net inflows of $87.8 billion were an improvement on the September quarter's $55.2 billion in total inflows and slightly higher than our forecast of $81.2 billion in inflows for the period. While iShares remains the largest driver of BlackRock's inflows, picking up another $50.3 billion in AUM during the fourth quarter, the firm did gather $39.0 billion in inflows with its institutional index business (with $11.9 billion going to equity funds and $27.1 directed to fixed-income offerings). Overall organic growth of 4.2% over the last four calendar quarters was below management's annual target rate of 5% but slightly above our long-term forecast of 3%-4%.

While quarterly average AUM was up 7.9% year over year, BlackRock's fourth-quarter revenue increased just 0.9% compared with the prior year's period, as product mix shifts, declining fee rates, and lower performance fees detracted from the company's top line. A 2.2% decline in full-year revenue as slightly worse than our forecast for negative 1%-2% revenue growth. With regards to profitability, the company's operating margins of 42.4% during the fourth quarter was enough to lift the firm's full-year margins to 41.0% (at the upper end of our 40%-41% forecast range). By our estimates, BlackRock generated $3.6 billion in free cash flow during 2016 and returned $2.7 billion to shareholders as share repurchases ($1.1 billion) and dividends ($1.6 billion).

Although GE Closes 2016 With Anemic Sales, Strong Order Book Bodes Well for Long Run
by Barbara Noverini | 01-20-17

Shares of wide-moat General Electric look fully valued relative to our $30 per share fair value estimate, as the company closed the books on 2016 with rather anemic fourth- quarter results. Excluding Alstom, industrial segment revenue declined by 1% year over year, reflecting ongoing weakness in the oil and gas and transportation segments, which each reported double-digit declines in organic revenue growth. However, when including Alstom's revenue starting in November 2015, GE's industrial organic sales increased 4%. In our view, Alstom's strong contribution bodes well for the burgeoning growth story in GE's power segment, which continues to see strong orders in both gas turbines and power services. With Alstom, GE Power grew revenue organically by an impressive 15% year over year. In addition, GE's renewables, healthcare, energy connections, and aviation segments all reported strong organic sales gains.

GE's legacy industrial segment operating profit margins expanded 10 basis points to 19.4% in the fourth quarter. Gross margins fell about 10 basis points, as unfavorable mix more than offset pricing gains and cost productivity. That said, additional progress in GE's SG&A simplification efforts managed to produce overall industrial operating profit margin expansion. Including Alstom, industrial EBIT margins declined 100 basis points to 17.3% year over year, largely because of the dilutive effect of Alstom's lower-margin businesses; however, management indicated that synergy achievement is ahead of plan, with efforts contributing approximately 100 basis points of cost savings in the quarter.

For the first time in two years, GE's oil and gas segment reported positive order growth, led by turbomachinery equipment. In our view, the continuation of this positive trend, combined with strong order growth in power, aviation, renewables, and healthcare, makes low to mid-single-digit organic revenue growth and approximately 10% growth in earnings look reasonable for 2017.

Citigroup and Wells Fargo Remain Undervalued Post-Earnings
by Jim Sinegal | 01-18-17

Fourth-quarter bank earnings supported our view that Citigroup remains the most attractive of the large U.S. banks. We believe that the company has a clear path to higher returns on equity as it returns excess capital ($14 billion supporting legacy assets alone) and continues to reduce expenses (10% of the expense base is related to Citi Holdings and restructuring efforts). Yet, the bank trades at a 10% discount to tangible book value per share while competitor Bank of America trades at a 33% premium despite only marginally higher profitability.

We see Wells Fargo as a close second, with the highest dividend yield (2.8%) among the large banks. Growing deposit balances and a stable level of account closings provide evidence that the account sales scandal will not have long-lasting effects on profitability. We expect the advantages created by the bank's base of low-cost deposits to grow as interest rates rise and believe that aligning employee incentives with customer interests will benefit the bank in the long run.

We see Bank of America and JPMorgan as fully valued. Each trades at approximately 13 times forward earnings and at significant premiums to our $22 and $72 respective fair value estimates. We believe market optimism is somewhat overdone with respect to the benefits from interest rate movements and regulatory changes. The underlying economic reasons for low rates--demographic changes, the effects of technology on employment, and the state of the leverage cycle--have not changed dramatically in the past quarter. Furthermore, JPMorgan CEO Jamie Dimon confirmed our view that many of the benefits from changes to tax rates and other industrywide constraints will largely accrue to customers and employees rather than shareholders due to the highly competitive nature of the banking business.

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©2017 Morningstar, Inc. All rights reserved. The Morningstar name and logo are registered marks of Morningstar, Inc. The information contained in this document is the proprietary material of Morningstar, Inc. Reproduction, transcription, or other use, by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited. All data presented is based on the most recent information available to Morningstar, Inc. as of the release date and may or may not be an accurate reflection of current data.  There is no assurance that the data will remain the same.

Disclosure:
The commentary, analysis, references to, and performance information contained within Morningstar® StockInvestorSM, except where explicitly noted, reflects that of portfolios owned by Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies managed by Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc. References to "Morningstar" refer to Morningstar, Inc.

Opinions expressed are as of the current date and are subject to change without notice. Morningstar, Inc. and Morningstar Investment Management LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only and has not been tailored to suit any individual.

The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Investments in securities are subject to investment risk, including possible loss of principal.  Prices of securities may fluctuate from time to time and may even become valueless.  Securities in this report are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information. Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

Common stocks are typically subject to greater fluctuations in market value than other asset classes as a result of factors such as a company's business performance, investor perceptions, stock market trends and general economic conditions.

All Morningstar Stock Analyst Notes were published by Morningstar, Inc. The Weekly Roundup contains all Analyst Notes that relate to holdings in Morningstar, Inc.'s Tortoise and Hare Portfolios.

David Harrell may own stocks from the Tortoise and Hare Portfolios in his personal accounts.

 
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