By Carla Fried
It was just a mere three months ago that Morningstar's proprietary analysis of Facebook's (NASDAQ:FB) fair market value estimated that the stock was trading at a 30% discount. That earned the stock a place in the Market Vectors Wide Moat ETF (NYSEARCA:MOAT) during the third quarter. The ETF, rebalanced quarterly, tracks Morningstar's index of the 20 companies with broad competitive advantages that are selling at the most compelling valuation.
In its latest rebalancing for the fourth quarter, Facebook has been kicked out of the Market Vectors Wide Moat ETF. Morningstar has not budged from its $34 per share fair value estimate. Yet after a surprisingly strong second quarter revenue showing -- which hit the wires in July -- Facebook more than doubled in the third quarter.
At a recent price of $51 per share, Facebook now trades at about a 50% premium to Morningstar's fair value estimate. That's too dear a price to stay in the value-oriented ETF. (Full disclosure: Morningstar is an investor in YCharts.)
Facebook certainly did the heavy lifting for the Market Vectors ETF during the third quarter. At the start of each quarter the 20 wide moat stocks in Morningstar's database trading at the biggest discount to fair value are equal weighted at 5%. By the end of the quarter Facebook had grown to more than 8% of the $361 million portfolio, as its stock price more than doubled in just three months.
FB data by YCharts
Though Facebook's meteoric rise in just one quarter is by no means the norm, the methodology behind the ETF has managed to deliver index-besting performance over the longer term. The 14.4% annualized five-year return for the Morningstar index through September is well ahead of the 9.3% annualized total return for the S&P 500 index. In the 17 months since the Market Vectors ETF launched its 32% gain is eight percentage points ahead of the S&P 500.
That's a pretty nice endorsement for the notion of focusing on companies with competitive advantages that are selling at a compelling valuation….and selling 'em when they no longer have the valuation tailwind.
Facebook wasn't the only wide-moater to get the boot from the Market Vectors Wide Moat Focus index for the fourth quarter. Eight other stocks were sold due for a lack of a compelling discount: Expeditor's International (NASDAQ:EXPD), Qualcomm (NASDAQ:QCOM), National Oilwell Varco (NYSE:NOV), Schulmberger (NYSE:SLB), Vulcan Materials (NYSE:VMC), Maxim Integrated Products (NASDAQ:MXIM), Amgen (NASDAQ:AMGN) and Caterpillar (NYSE:CAT) were also ditched. In the case of Caterpillar, Morningstar's reduction in its fair value estimate from $98 per share to $94 squeezed its fair value discount to around 10% at the time of the index's rebalancing.
The three cheapest stocks in the index at the start of the fourth quarter are Exelon (NYSE:EXC) with a current estimated discount of 28% and Western Union (NYSE:WU) and Express Scripts (NASDAQ:ESRX) at 26% discounts. All three were in the portfolio last quarter as well. While Western Union and Exelon saw their discounts narrow slightly, Express Scripts' 26% discount at the time of the latest rebalancing is a big drop from the 15% discount at the beginning of the third quarter. That's got nothing to do with a faltering business; just the opposite, as Morningstar recently jacked up its fair value estimate from $73 to $89 per share. Morningstar's valuation model expects annualized revenue growth of 5.1% over the next five years and for operating margins to average 6.4% over that stretch:
ESRX Revenue TTM data by YCharts
While Apple trades at a 25% discount to Morningstar's $600 per share estimate of fair value, the stock doesn't have dominant enough competitive advantages to merit a Wide moat designation; its moat is rated Narrow. Google does have wide-moat status, but according to Morningstar's analysis it current trades at a 14% premium to fair value. So among the top three most admired global brands, Coca-Cola is the only one to claim a wide moat selling at a compelling valuation . . . for this market.
That last qualifier is important. As you'd expect in this rising market where earnings growth has slowed down and multiples expanded, it's not as if there's a big pot of high-quality cheap stocks to choose from. At the beginning of the third quarter, 14 of the 20 stocks in the wide-moat ETF had discounts of at least 15% to their fair value. At the fourth-quarter rebalancing, just six of the 20 stocks had such a wide discount.
Coca-Cola has been losing some luster among top investors of late. Morningstar recently noted that the stock is no longer showing up as a common holding among its small universe of ultimate stock pickers.
Indeed, there's no deep value play to be had here, as evidenced by a 20 PE ratio.
But Coca-Cola -- one of the most respected high-quality firms out there --barely sells at a premium to the 19.5 2013 estimated average PE for the consumer defensive sector within the S&P 500.
Meanwhile it remains focused on returning cash to shareholders. The dividend has grown more than 45% over the past five years and a 2.9% current dividend yield still managed to outpace the 10-year Treasury bill. Meanwhile, aggressive share repurchase pushes the net shareholder yield to close to 6%.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at email@example.com.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.