Half-Time Heroes: Moat Stocks Are Ready for The Next Challenges
14 August 2023
The first half of the year is officially complete, and this lopsided tech rally is possibly becoming one of the most hated bull markets in history. U.S. equities have refused to slow down despite debt ceiling angst, regional banking fears, continued tightening credit conditions, and a commercial real estate market teetering on the edge. In the face of these concerns, the Nasdaq registered its strongest first-half performance in 40 years with a gain of over 31%. Additionally, Apple, the world's most valuable company, closed above the $3 trillion market capitalization mark for the first time.
Morningstar® US Sustainability Moat Focus Index also had a strong start with a tech rally at least partially contributing to its success. The events of the first half of the year heavily influenced the index composition, which rebalanced on 16 June 2023.
Bull or Bear: Morningstar’s View on Sectors
It is crystal clear that tech stocks were investors’ favorites this year. In 2022, the technology industry faced a challenging period. However, the first quarter of 2023 marked a resurgence, followed by an even more pronounced upswing in the second quarter. This surge can be attributed, at least in part, to the immense excitement and demand for everything related to artificial intelligence. Several companies especially benefited from the trend (a good example is NVIDIA joining the trillion-dollar club), but some valuations of tech stocks, according to Morningstar’s research, might be overheated, especially those with wide moats.
On the other hand, some sectors found themselves traded at a sharp discount compared to their fair value estimates. Amidst concerns over the value of telecom companies, the recent uptick in prices signals positive prospects for wireless carriers. Other subsectors, like Financial Services or Basic Materials, also display growth potential.
Moats might not always be priced-in, but according to Morningstar data, some sector valuations not only accounted for Moats but also overvalued them.
Morningstar Price/Fair Value Metric by Sector Weighted by Intrinsic Value
Figures below 1 are undervalued, while above 1 are overvalued.
Source: Morningstar, Data as of 26 June 2023.
Morningstar Price to Fair Value Metric by Sector for Wide Moat Rated Stocks
Source: Morningstar, Data as of 30 June 2023.
Underweighting Tech Results in a Soft Start
The US Market had one of the strongest half-year marathons in its history, and its main benchmark, the S&P 500 Index, finished the first six months up by 16.6%, overperforming Morningstar US Sustainability Moat Focus Index by close to 460 basis points. Underweighting Communication Services and Consumer Discretionary sectors left the performance of the Moat index trailing S&P while underweighting Energy helped to shorten the distance between the two. Some champions of 2023 (e.g., Meta Platforms returned 138.5% between January and July) were also excluded from the index.
Moat Index Highlights
So Long Tech, Until We Meet Again
The Moat Index saw its technology exposure increase at the end of 2022, following the drastic declines in valuations for the sector. Now, with the incredible rally that many of these companies experienced in the first half of the year, their valuations have become too lofty. Following this trend, the Moat Index shifted exposure to other areas of the market with more attractive valuations. The reduced exposure of this review came by way of software companies and semiconductor companies, with Adobe and KLA Corp being the most notable names removed from the index. Please note that these companies are just examples representing a small portion of the total portfolio.
Dan Romanoff, Senior Equity Analyst at Morningstar on Adobe Inc. (ADBE):
“Management continues to talk about pushing margins higher over time but given the company’s margins are already right near the top of software group, we think expansion will be more incremental from here.”
Price to Fair Value for Adobe Inc (ADBE) – January – July 2023
Source: Morningstar.
William Kerwin, Analyst at Morningstar on KLA Corp (KLAC):
“Front-end wafer fabrication equipment, or WFE, is in the midst of a downturn in calendar 2023, with both memory and logic chipmakers reducing spending with lower end demand. However, KLA’s services revenue grew nicely in the quarter, showing continued use by customers despite lower capital expenditure. … With a dominant position in the process diagnostic and control market that results in a wide moat rating, we’re confident KLA will capture demand when the WFE market rebounds. We find valuation challenging at the moment.”
Price to Fair Value for KLA Corp (KLAC) – January – July 2023
Source: Morningstar.
Communication Services and Healthcare are Shining Again
Healthcare and Communication services were the primary beneficiaries of the above-mentioned valuation-driven shift away from technology names. From the healthcare sector, the new additions are from the biotech, medical technology, and life sciences sub-industries. These additions include Biogen (BIIB), Zimmer Biomet Holdings (ZBH) and Agilent Technologies (A), among others. On the communication services side, names added to the index include Comcast (CMCSA), and Walt Disney (DIS).
Karen Andersen, Sector Strategist at Morningstar on Biogen Inc (BIIB):
“We think barriers to entry are high for potential biosimilars to Biogen’s products, and the company has a strong R&D strategy for maintaining its leadership in MS and neurodegenerative diseases, where pricing power is strong, patient need for novel therapies is high, and it has been building a solid pipeline.”
Price to Fair Value for Biogen Inc (BIIB) – January – July 2023
Source: Morningstar.
Neil Macker, Senior Equity Analyst at Morningstar on Walt Disney Co (DIS):
“Its media networks segment and collection of Disney-branded businesses have demonstrated strong pricing power in the past decade. We believe that the addition of the Fox entertainment assets will continue to help the firm generate excess returns on capital despite operating in the increasingly competitive media marketplace, including within the streaming landscape.”
Price to Fair Value for Walt Disney Co (DIS) – January – July 2023
Source: Morningstar.
Accessing Moat Stocks
VanEck Morningstar US Sustainable Wide Moat UCITS ETF (MOAT) seeks to provide investment returns that closely track the price and yield performance of the Morningstar US Sustainability Moat Focus Index.
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The information is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice VanEck (Europe) GmbH, VanEck Switzerland AG, VanEck Securities UK Limited and their associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this information. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results. Information provided by third party sources is believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Brokerage or transaction fees may apply.
VanEck Asset Management B.V., the management company of VanEck Morningstar US Sustainable Wide Moat UCITS ETF (the "ETF"), a sub-fund of VanEck UCITS ETFs plc, is a UCITS management company under Dutch law registered with the Dutch Authority for the Financial Markets (AFM). The ETF is registered with the Central Bank of Ireland, passively managed and tracks an equity index. Investing in the ETF should be interpreted as acquiring shares of the ETF and not the underlying assets. Investors must read the sales prospectus and key investor information before investing in a fund. These are available in English and the KIIDs/KIDs in certain other languages as applicable and can be obtained free of charge at www.vaneck.com, from the Management Company or from the following local information agents:
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