As we look back on a first quarter which saw the US equity market up more than 9% in 2024 as measured by the Morningstar US Market Index, it may be time for style investors to revisit their portfolio, according to new insight from Morningstar Indexes.
A new report by Morningstar Indexes Director of Equity Product Management Alex Bryan suggests that applying a “moat” framework that combines durable competitive advantages with attractive valuations could help style investors avoid traps that may emerge over time.
A growth-oriented portfolio may hit a “growth trap” by focusing on fast-growing companies regardless of price, while a value-oriented portfolio may hit a “value trap” when it focuses on price without regard to underlying quality. These traps are evident when comparing the characteristics of traditional market cap-weighted Morningstar style indexes to the Morningstar US Broad Style Wide Moat Focus indexes. The new indexes utilize a moat framework, which draws on forward-looking insights from the Morningstar Equity Research team to screen constituents with durable competitive advantage and attractive valuations.
- Constituents in the Morningstar US Market Broad Growth Extended Index covered by Morningstar equity research analysts currently trade at an asset-weighted average price/fair value ratio of 1.08, while the corresponding figure for the Morningstar US Broad Growth Wide Moat Focus Index is 0.89. This suggests that investors in the broad growth segment of the market are slightly overpaying for those stocks’ strong growth prospects. In contrast, the Morningstar US Broad Growth Wide Moat Focus Index is more selective, targeting stocks whose future cash flows may not be fully appreciated.
- Traditional value stocks may often be cheaper than growth stocks, but they are not necessarily bargains, as their low valuations may point to high risk or low growth. The Morningstar US Broad Value Wide Moat Focus Index screens for value traps by looking for stocks with Morningstar Economic Moat Ratings of Wide, indicating they enjoy a durable competitive advantage that will likely set up strong returns on invested capital over the next 20 years. All constituents in this index must have a wide moat rating to enter, while just 47% (by weight) of the Morningstar US Market Broad Value Extended Index have achieved this designation.
Alex Bryan – Director of Equity Product Management, Morningstar Indexes:
“Extended equity market runs can lay traps for traditional style investors. Without a rigid price discipline, growth-oriented portfolios can become more concentrated in relatively high-priced issuers and sectors. And without screening for higher-quality companies with durable competitive advantages, value-oriented investors can end up with holdings that may look cheap but disappoint because they don’t have a sustainable competitive advantage.”
Brandon Rakszawski – VP, Director of Product Management, VanEck ETFs:
“Investors looking for growth but concerned about the overconcentration that can occur in traditional market cap-weighted growth strategies may want to consider adding a moat-oriented lens to their growth-style exposure. At the same time, value-oriented approaches that focus solely on stock price without a quality lens can also cause challenges for investors, and a moat lens can be helpful here as well.”
©2024 Morningstar. All Rights Reserved. The information, data, analyses and opinions contained herein (1) include the proprietary information of Morningstar, (2) may not be copied or redistributed, (3) do not constitute investment advice offered by Morningstar, (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be correct, complete or accurate. Morningstar has not given its consent to be deemed an "expert" under the federal Securities Act of 1933. Except as otherwise required by law, Morningstar is not responsible for any trading decisions, damages or other losses resulting from, or related to, this information, data, analyses or opinions or their use. References to specific securities or other investment options should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment. Past performance does not guarantee future results. Before making any investment decision, consider if the investment is suitable for you by referencing your own financial position, investment objectives, and risk profile. Always consult with your financial advisor before investing.
Indexes are unmanaged and not available for direct investment.
Morningstar indexes are created and maintained by Morningstar, Inc. Morningstar® is a registered trademark of Morningstar, Inc.