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| What were the methodology design objectives? |
| To create robust asset allocation and measurement tools,
Morningstar's research team designed the indexes to satisfy the following
objectives: |
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broadly represent the market without sacrificing investability |
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consistently measure stocks' value and growth orientation
in line with market practitioners and stock analysts |
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maximize performance distinctions between growth and
value—higher negative correlations between growth and value stocks |
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classify each stock uniquely (i.e., each stock belongs
to only one of the nine style indexes) |
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minimize turnover |
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utilize current best practices in index maintenance
and construction methods (such as free-float weighting) |
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| How were the style methodology factors chosen? |
| We chose the fundamental balance sheet and market factors
that would best measure and describe the separate "value"
and "growth" characteristics of common equities. To reflect
the fact that fund managers look at both historical and projected
measures of company characteristics, Morningstar assigned a 50% weighting
to the forward-looking estimates. The 10-factor model's results were
evaluated using different factor weightings to satisfy the index design
criteria: a high negative correlation between the composite value
and growth scores, accurate classifications, and good classification
stability. The weightings selected produced superior results. |
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| Is the methodology subjectively determined? |
| Morningstar's indexes are governed by transparent,
objective rules for security selection, exclusion, rebalancing, and
adjustments for corporate actions. Morningstar makes no subjective
determinations related to index composition. For a complete documentation
of the construction and maintenance rules, please see Rulebook (PDF). |
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| What are the index eligibility requirements? |
| To be eligible for Morningstar's indexes, a stock must
be |
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listed on the NYSE, the AMEX, or Nasdaq |
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domiciled in U.S. or its primary stock market activities
are carried out in the U.S. |
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have sufficient historical fundamental data available
to classify its investment style |
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in the top 75% of companies in the investable universe
based on its liquidity score |
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have more than 10 non-trading days in the prior quarter |
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are American Depository Receipts and American Depository
Shares, fixed-dividend shares, convertible notes, warrants, rights,
tracking stocks, limited partnerships and holding companies |
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| For a complete description of Morningstar's
index eligibility requirements, please refer to Rulebook (PDF). |
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| How does Morningstar determine its cap cut-offs? |
| Morningstar uses a dynamic percentage-based approach
to divide its U.S. Market Index into three cap indexes. By defining
each as a percentage of the market cap of the investable universe,
the definitions remain stable regardless of market movements. |
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Large Cap
Largest 70% of investable market cap
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Mid Cap
Next 20% of investable market cap
(70th to 90th percentile) |
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Small Cap
Next 7% of investable market cap
(90th to 97th percentile) |
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| How does Morningstar assign stocks to the
indexes? |
| Within each capitalization class, index constituents
are assigned to one of three style orientations—value, growth
or core—based on the stock's overall style score. A stock's value
orientation and growth orientation are measured separately using related
but different variables. For a complete description of the process,
please refer to Rulebook. |
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| Value Factors |
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Price/projected earnings (50.0%) |
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Price/book (12.5%) |
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Price/sales (12.5%) |
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Price/cash flow (12.5%) |
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Dividend yield (12.5%) |
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| Growth Factors |
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Long-term projected earnings growth (50.0%) |
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Historical earnings growth (12.5%) |
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Sales growth (12.5%) |
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Cash flow growth (12.5%) |
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Book value growth (12.5%) |
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| How frequently do you rebalance the indexes? |
| Morningstar rebalances constituent shares and weights
of its indexes quarterly in March, June, September, and December (on
the Monday following the 3rd Friday). Immediate rebalancing occurs
if two constituents merge or a company's free-float changes by 10%
or more. The indexes are reconstituted twice annually in June and
December. |
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| What data sources are used in
the Morningstar indexes? |
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| Data |
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| Security prices |
SIAC and Nasdaq data feed |
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| Corporate Actions |
IDC, Dow Jones Newswire, and primary exchange and
press announcements |
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| Fundamental Data |
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Five years of restated financial data is sourced
from Mergent, Inc. |
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Earnings estimates are provided by IBES |
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Morningstar normalizes the data and generates
the price ratios and growth rates |
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Morningstar uses restated financials data for
calculating fundamental factors |
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| Float |
Proxy statements, 13-F, 10-K, and registration statements |
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| Why does Morningstar use free-float? |
| Full market capitalization represents the overall economic
importance of a company. However, if corporate insiders hold a large
portion of shares outstanding, then an investor seeking a proportional
equity exposure may end up pursuing shares of the company that may
not be available. For example, Wal-Mart has less than 60% of its shares
available to the public for investing. If the full weight of the company
is used in the index, the demand for Wal-Mart shares could outstrip
the supply, causing price distortions. Therefore, using the free float
instead of the full capitalization improves the investability of the
index. |
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| What are some examples of free-float adjustment? |
| As of June 26, 2002, the following examples of block
ownership would require float adjustment |
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Microsoft's Bill Gates privately owned more than 12%
of the company's outstanding shares |
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Fiat had a 5.6% ownership in General Motors, which
is a case of cross ownership and would require an adjustment to GM's
shares to reflect true investability. |
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State Street Bank and Trust Co had a 9.3% stake in
Morgan Stanley Dean Witter. Although State Street is an investment
firm, this particular holding is a trust for a company-sponsored,
equity-based compensation program (employee benefit plans). Morningstar's
rules state that both employee benefit plans and trusts are considered
block ownership. |
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