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.

Oct 21, 2016
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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, 10/14/2016 -- A CEO Resignation and Third-Quarter Results for Wells Fargo

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.

This week in Morningstar analyst notes: a CEO resignation and third-quarter earnings for Wells Fargo WFC (separate notes), and third-quarter earnings for Unilever UL.

Also, if you didn't see it, Matt Coffina purchased Facebook FB for Morningstar's Hare portfolio on Tuesday. You can read his trade alert here.

Wells Fargo Weathers the Storm in the Third Quarter

by Jim Sinegal | 10-14-16

Wells Fargo's third-quarter results showed little impact from the sales scandal that ended the career of former CEO John Stumpf only days ago, and we are maintaining our $62 fair value estimate for the bank. We think the company is off to a good start in dealing with the problems created by inappropriate sales incentives, and we are maintaining our wide moat rating and Exemplary stewardship rating--reflecting its superior capital allocation, not necessarily corporate behavior--in light of the company's impressive returns on tangible common equity (14% in the third quarter) and healthy capital return program. We saw little evidence that the aggressive and occasionally fraudulent sales practices--or the media and regulatory attention around them--drove customers away from the bank. Average deposits expanded from $1.2367 trillion in the second quarter to $1.2615 trillion in the third quarter, with little change in the proportion of non-interest-bearing accounts. Period-end deposits totaled $1.2759 trillion, up from $1.2455 trillion in the June quarter. Primary consumer checking customers—those who actively use their accounts—expanded by 4.7% during the last 12 months, the same rate as in the prior quarter. In our view, this demonstrates that Wells Fargo is not only maintaining accounts, but that most accounts demonstrate a healthy level of activity--unlike the fraudulent accounts created over the past half-decade. We also believe that the advantages of scale and scope outweigh the difficulties in managing such a large organization. Customer relationships remain deep, with 6.25 products apiece, and the efficiency ratio was an acceptable 59.4%.

Cross-selling numbers in the community banking segment remained relatively flat in the third quarter, confirming our thesis that the most impactful changes to sales practices likely occurred earlier in the investigation.

Consumers also continued to borrow from the bank. Mortgage originations rose 11% during the year, though referrals from the retail bank were apparently down as the bank revamped sales goals.

Wells also used consultants to improve and better police its front-line sales practices. Spending on outside professional services rose by $33 million--money we think is well-spent. Wells has been dealing with faulty sales practices for some time, and we are encouraged that spending on corporate risk practices and outside contractors increased well before the $100 million Consumer Financial Protection Bureau fine was announced. Consulting and contract spending actually rose by 22% in the third quarter. However, this increased level of spending should not materially affect returns on capital. Aside from a $243 million increase in operating losses, other expenses were fairly well controlled, resulting in a 7% annual increase in noninterest expenses.

Not surprisingly, issues with consumer accounts had little effect on Wells Fargo's corporate business, which accounts for more than one third of net income. Wells Fargo's investment banking market share actually rose from 4.3% to 4.6% during the year. Net income from the wholesale banking segment grew by 6% during the year, indicating continued momentum in spite of the well-publicized defection of some government clients.

On the capital allocation front, Wells paid out 61% of net income to shareholders, mostly in the form of its $0.38 per share dividend. We see the generous payout policy--and the company’s inability to participate in much M&A--as protection against management missteps, and think the company's 3.4% dividend yield supports our valuation estimate. In a tough operating environment, under heavy media and regulatory scrutiny that led to the departure of its CEO, the wide-moat bank still managed to generate a 1.17% return on assets.

Third Quarter Demonstrates the Importance of Unilever Pricing as Tesco Pushes Back on Price Increase
by Philip Gorham, CFA, FRM | 10-13-16

Unilever's third-quarter organic sales growth of 3.2% puts the firm comfortably on track to meet our full-year forecasts, but the report is likely to be overshadowed by news that Tesco has withdrawn many Unilever products from its U.K. website. We are reiterating our EUR 40 and $44 respective fair value estimates for the Amsterdam-traded shares and their ADR counterparts, but we are raising our valuation of the London-traded PLC shares to GBX 3,600 from GBX 3,250 to account for the significant weakening in sterling against the euro since our last update. The price skirmish with Tesco will shine a light on what we believe to be the deterioration of pricing power in some consumer products categories, but we expect the mutually beneficial relationship between Unilever and its customers--the source of Unilever's wide economic moat--to ensure that a resolution is found sooner rather than later.

Third-quarter organic growth of 3.2% was a sequential slowdown from the 4.7% achieved in the first half of the year. Volumes fell 0.4%, in part due to a strong third quarter last year, in which volumes grew 4.1%, but also impacted by slowing demand growth, particularly in emerging markets. Value growth in developing markets slowed by 50 basis points to 7.2%. Price/mix of 3.6%, therefore, demonstrates the importance of pricing to Unilever's current growth algorithm, despite the deflationary environment in Europe.

Although no margin data was disclosed, we suspect that Unilever is beginning to feel the pain from rising input costs. Commodities such as palm oil and energy have risen substantially this year, and we expect the solid 80 basis points of gross margin expansion achieved in the first half of the year to have faded to around 50 basis points by the end of the year as cost inflation impacts the income statement.

Against this backdrop of slowing growth, weak volumes and rising commodity costs, Tesco has removed Unilever products across multiple categories from its online platform after Unilever attempted to pass through a 10% price increase on certain food products. Pricing negotiations between consumer staples retailers and manufacturers are often turbulent, but it is quite rare that the supply chain be disrupted in this manner. A similar situation occurred in 2009, when Delhaize removed around 250 Unilever SKUs from its stores in Belgium, and in the same year, Costco temporarily suspended sales of Coca-Cola products in the U.S. In both cases, the disputes were fairly short-lived with product supply being restored within weeks after compromise was reached.

However, as we highlighted in our Observer of October 2015, "Shopping for the CPG Brands Best Positioned for a New Era in Commerce," there have been significant changes in both consumer behaviour and the retail landscape since 2009. The growth of the hard discounters has pressured footfall in the midpriced supermarkets in Europe, and in many cases, the turnaround of the mainstream banners is largely dependent upon the execution of low-price strategies. Simultaneously, consumers have become more value conscious, as limited real wage growth and greater price transparency have fostered a willingness to scrutinise the added value of branded products. This has weakened the position of the manufacturers, particularly those lacking a significant number of category leadership positions, and for products not purchased or consumed in a social environment. We think Unilever, with its positioning in home care and packaged food, may be particularly susceptible to weakening pricing power in the long term.

Ultimately, we expect the situation to be resolved with limited impact on Unilever because the manufacturer is entrenched in Tesco's supply chain. Given the breadth of Unilever's portfolio across many categories, and its ability to invest behind brands and to deliver new product innovation, it would be difficult for competitors, particularly new entrants, to steal material shelf space. Nevertheless, the strength of the pushback on price from Tesco is further evidence to support our thesis that the pricing power of some consumer products brands may be eroding.

Wells Fargo Sales Scandal Ends Stumpf's Career
by Jim Sinegal | 10-12-16

Shortly after Wells Fargo CEO John Stumpf gave an underwhelming defense in front of Congress of the bank's sales practices, the bank announced that he will be retiring immediately, to be replaced by Chief Operating Officer Tim Sloan. We are maintaining our fair value estimate of $62 and wide-moat rating.

The announcement brings a quick and ignominious end to Stumpf's otherwise admirable tenure as CEO. Since Stumpf took over in mid-2007, Wells Fargo's stock price rose by 29%, excluding dividends, while the XLF financial sector ETF fell by 46% over the same period. The company also doubled in size with the risky acquisition of troubled Wachovia early in his term, successfully integrating the firm and expanding its footprint into the Southeastern United States. Wells Fargo's relationship with regulators prior to the account scandal had also been relatively painless, with the company receiving approval to pay out nearly 30% of earnings in the form of dividends as early as mid-2012.

However, these successes were largely erased in the minds of investors, regulators, politicians, the public, and the company's board of directors when the scale of the bank's high-pressure sales tactics was revealed. It remains to be seen if customers will defect en masse, but we believe the company's convenient branch network and otherwise healthy customer satisfaction--JD Power scores the bank average or better in all but one region of the country--will result in business stability. We expect Sloan to bring more detail-oriented oversight to the top job while not straying too far from the culture that led to Wells Fargo's relative success over the past several decades. We remind investors that the fraudulent practices did not contribute to the company's financial success.


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