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On March 18, VanEck disclosed the latest changes to the MOAT ETF (BATS: MOAT), which tracks Morningstar® Extensive Moat Focus Index. These quarterly updates provide insight into sectors and companies that Morningstar’s core analysis considers as undervalued. Following the recent battle of volatility, fair value discounts are higher than we have been accustomed to in previous quarters. This is good news not only for investors interested in the MOAT ETF itself, but also for stock pickers who can sift through ETF holders looking for blue chips trading at a reasonable cost (see full list at end of this article).
Let’s start with an overview of ETF performance at present, comparable to major indices. Also noteworthy, that MOAT’s international counterpart MOTI (MOTI) also surpassed international markets (ex-US) during:
Another interesting aspect of the MOAT restructuring in March was Morningstar’s renewed confidence in some of Big Tech’s top names. In particular, Morningstar saw a Price To Fair Value ratio of 0.48 when it comes to Meta Platforms (FB), suggesting a 52% discount and, therefore, a potential stock doubling. These metrics were calculated in early March, and Meta has risen somewhat since then, but there is still a lot of headroom between the current price and Morningstar’s estimated fair value of $ 400 per share. VanEck summarizes Morningstar’s thesis as follows:
Meta Platforms (the company formerly known as Facebook) reported quarterly results after the markets closed on Feb. 2, sending shares into a free fall the next day. According to Morningstar, revenue was slightly ahead of expectations, but the company missed the bottom line due to increased investment not only in the Reality Labs metaverse segment but also in Reels and in overall improving its advertising back-end. Its earnings guidance in the first quarter of 2022 is also lower than consensus estimates.
Source: VanEck
Honestly, I have no opinion on the particular appreciation of Meta. For me, the clear takeaway is that Morningstar sees Big Tech as undervalued right now, compared to their analysis of other leading companies in the sector (all MOAT members):
- Amazon Price/Fair Value (AMZN) of 0.66 (34% off) in early March
- Alphabet’s (GOOGL) P/FV at 0.71 (29% off)
- MercadoLibre’s (MELI) P/FV at 0.58 (42% off)
- Salesforce’s (CRM) P/FV of 0.60 (40% off)
With this in mind, let’s examine in more depth the way the MOAT ETF works and the recent rebalance.
The MOAT ETF: An Overview
Note: Investors already familiar with the MOAT ETF and Morningstar methodology can skip this part and move directly to the March rebalance section.
The way the MOAT ETF works is well summarized by fellow contributor George Fisher in an earlier article:
[MOAT] owns 40 to 50 stocks with broad moats and trades at a fair value discount, usually in the 15% to 25% discount range. When moat ratings change or the fair value discount becomes relatively uncompetitive to others, the position will be replaced. Not only do the shares change based on the moat rating and discount to fair value, but the portfolio is rebalanced to an equal weight as well. This creates a relatively high annual portfolio turnover of approximately 25%.
The ETF, managed by VanEck, is based on Morningstar® Extensive Moat Focus Index, which includes only U.S. stocks and, as the name implies, only companies that possess broad moats in the economy. But what exactly does Morningstar mean by “economic moat”? According to VanEck:
Economic Moat ratings represent maintaining a company’s competitive advantage. The wide and narrow moat ratings represent Morningstar’s belief that a company can maintain its advantage for at least 20 years and at least 10 years, respectively. An economic moat rating of none indicates that a company is either an unprofitable or an unsustainable one. Among the quantitative factors used to define competitive advantages are returns on invested capital relative to cost of capital, while the qualitative factor used to determine competitive advantage includes customer switching cost, cost advantages, intangible assets. , network effects, and efficient scale.
Morningstar
Source chart: Morningstar
This approach has allowed MOAT to outperform the S&P 500 since it began in 2012, as reviewed by contributor The Sunday Investor in his article How MOAT Defeats S&P: A Performance Attitude Analysis. With this in mind, let us now discuss the latest steps as part of the recent reconstitution in March.
March Rebalance: The Removed Constituents
The recent reconstitution-affecting the sub-portfolio whose previous rebalancing was in September-saw the removal of eleven names:
VanEck
(see VanEck’s full document here)
All eleven stocks were removed on a valuation basis, i.e., Morningstar replaced them with more attractive new participants from a Price/Fair Value perspective. The departure, therefore, has nothing to do with downgrading these 11 stocks ’economic moat.
It may come as a surprise to see on this list some names that are really in favor right now, such as defense stocks Lockheed Martin (LMT) and Raytheon Technologies (RTX), or Cheniere Energy (LNG) that should benefit from the increased the shipments of LNG to Europe. The thing is, these stocks have performed well since the last reconstitution of the sub-portfolio and their analysis looks less attractive to Morningstar compared to other candidates (in doing so, the MOAT has missed out. the spectacular upleg last week in Cheniere).
It’s noteworthy that Berkshire, Lockheed and Cheniere are still part of another MOAT sub-portfolio, one that will rebalance in June, so eliminating them this month can be viewed as Morningstar/ VanEck taking only partial revenue.
March Rebalance: The New Entrants
The 11 names removed from the sub-portfolio gave way to another 11 broad moat companies:
VanEck
As discussed earlier, several tech stocks have been added, such as ServiceNow (NOW), Adobe (ADBE) and MercadoLibre, the Latin America-focused e-commerce platform. Another takeaway is that the discounts are substantial, from 42% in the case of MercadoLibre to 24% for 3M (MMM). This is more attractive than previous restructurings, when discounts were typically in the 10%region. In the same way, BlackRock (BLK) is seen as 34% undervalued, following the poor performance of the asset management giant’s stock since November 2021.
The One Waiting Beside
As always, VanEck provides a list of stocks that can be included as part of the next rebalance, if their values warrant it at that time, such as Comcast (CMCSA), Disney (DIS), and Starbucks (SBUX):
VanEck
The Full List
Below is the full list of 52 names currently included in the MOAT ETF. Right now, Compass Minerals (CMP) is the largest position, weighing in at close to 3% of the portfolio. Despite the company’s incredible performance in recent years, Morningstar has remained confident in this salt and potash producer. While higher logistics costs have been a drag on the profitability of the salt component, the potash segment should benefit from those supporting fertilizer prices.
VanEck
This list can be used as a source of ideas for investors seeking extensive trading of stocks at reasonable valuations in the face of recent volatility. In this regard, Price/Fair Value is a useful metric:
VanEck
(see this document for full details)
In terms of sector allocation, the deterioration at the end of February was as follows:
VanEck
Take away
The MOAT ETF showed little stability in the volatile environment of 1Q ’22, with higher performance in the broader market. Morningstar’s early forecasts on defense stocks in 2021, and on the likes of Cheniere Energy, have been rewarded (leading to the trimming of some of these names on the basis of analysis). Morningstar now sees the opportunity with Big Tech, whose most notable call is their fair value estimate of $ 400 for Meta Platforms, and MOAT will benefit if their analysis is proven correct.