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Wide-Moat Stocks On Sale - The August 2020 Heat Map

The FALCON Method
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Summary

Our 3-step process focuses on wide-moat stocks (as per Morningstar's rating).

We are only interested in those targets that are attractively valued in historical comparison.

We share the heat map of the most investable candidates that may be worth your time for further analysis.

Step One: Wide-moat stocks with 5-star and 4-star ratings

Historical evidence says that while quality alone is a poor indicator of outperformance, when combined with a decent valuation filter, Morningstar's moat rating proves to be more than useful. Based on the available data, stocks with a wide-moat rating that also fit into the 4- or 5-star category deserve to be the subject of further analysis. See the detailed explanation and the underlying evidence of our first step in this article.

We focus on those companies that are covered by a Morningstar analyst as assigning a wide-moat rating without thorough analysis is a questionable practice in our opinion. As of July 26, there were 176 wide-moat stocks meeting our criteria.

Only 4.5% (8 stocks) of this wide-moat group earned a 5-star (most attractive) valuation rating. Here are they:

Company Name Ticker
Anheuser-Busch InBev SA/NV BUD
Baidu Inc. BIDU
Bayer AG OTCPK:BAYRY
British American Tobacco PLC BTI
Core Laboratories NV CLB
Imperial Brands PLC OTCQX:IMBBY
Philip Morris International Inc PM
Wells Fargo & Co. WFC

We believe that the percentage of 5-star-rated wide-moat stocks is a good indicator of market sentiment. When this percentage is high, even the best companies are on sale. When the percentage is extremely low, market conditions may warrant caution. (Please note that this is not an indicator for market timing!)

It is no surprise that as the market climbs higher, the percentage of 5-star-rated wide-moat stocks declines further as seen on the chart below.

As these best of breed companies may be worth a closer look even when they are just slightly cheaper than their fair value but are not in the bargain bin, we also list the 4-star-rated wide-moat stocks as of July 26:

Company Name Ticker
Altria Group Inc. MO
Ambev SA ABEV
American Express Co. AXP
Aspen Technology Inc. AZPN
BAE Systems PLC OTCPK:BAESY
Berkshire Hathaway Inc. BRK.B
Biogen Inc. BIIB
Blackbaud Inc. BLKB
Boeing Co. BA
Bristol Myers Squibb Co. BMY
Charles Schwab Corp. SCHW
Coca-Cola Co. KO
Compass Minerals International Inc. CMP
Constellation Brands Inc. STZ
Corteva Inc. CTVA
Enbridge Inc. ENB
Enterprise Products Partners LP EPD
General Dynamics Corp. GD
Gilead Sciences Inc. GILD
Grupo Aeroportuario del Pacifico SAB de CV PAC
Grupo Aeroportuario del Sureste SAB de CV ASR
Intel Corp. INTC
John Wiley & Sons Inc. JW.A
Julius Baer Gruppe AG OTCPK:JBAXY
Kellogg Co. K
Lockheed Martin Corp. LMT
Magellan Midstream Partners LP MMP
Medtronic PLC MDT
Merck & Co., Inc. MRK
Microsoft Corp. MSFT
Pfizer Inc. PFE
Raytheon Technologies Corp. RTX
Roche Holding AG OTCQX:RHHBY
Royal Bank of Canada RY
Starbucks Corp. SBUX
The Toronto-Dominion Bank TD
U.S. Bancorp USB
Westpac Banking Corp. WBK
Zimmer Biomet Holdings Inc. ZBH

All in all, we have 47 firms that pass our very first criteria. (Down from 55 a month ago.)

Step Two: Historical Valuation in the EVA Framework

We believe that the most widely used valuation multiples are terribly flawed. See this article on why we consider the Future Growth Reliance metric the best-of-breed sentiment indicator that addresses accounting distortions, thus gives us a true picture of which wide-moat companies seem attractively valued in historical terms. We want to buy our top-quality targets when the baked-in expectations are low, since that is when surprising on the upside has the highest probability. As investment is a game of probabilities, all we can do is stack the odds in our favor as much as possible.

28 of the 47 stocks survived this second step. Here's the list:

Company Name Ticker
Altria Group Inc. MO
Ambev SA ABEV
Anheuser-Busch InBev SA/NV BUD
Aspen Technology Inc. AZPN
Biogen Inc. BIIB
Bristol Myers Squibb Co. BMY
British American Tobacco PLC BTI
Charles Schwab Corp. SCHW
Core Laboratories NV CLB
Enterprise Products Partners LP EPD
Julius Baer Gruppe AG OTCPK:JBAXY
General Dynamics Corp. GD
Grupo Aeroportuario del Pacifico SAB de CV PAC
Grupo Aeroportuario del Sureste SAB de CV ASR
Imperial Brands PLC OTCQX:IMBBY
Intel Corp. INTC
John Wiley & Sons Inc. JW.A
Lockheed Martin Corp. LMT
Magellan Midstream Partners LP MMP
Merck & Co., Inc. MRK
Philip Morris International Inc. PM
Raytheon Technologies Corp. RTX
Royal Bank of Canada RY
Starbucks Corp. SBUX
The Toronto-Dominion Bank TD
U.S. Bancorp USB
Wells Fargo & Co. WFC
Westpac Banking Corp. WBK

We are rather strict when it comes to historical valuation. There are stocks that unquestionably fail both our short- and long-term tests like Microsoft:

Source: evaexpress.com

There are some targets, however, that may look attractively valued if you only focus on the short term (like the last 5 years), but the longer you zoom out, the more you lose your appetite. Kellogg comes to mind as an example:

Source: evaexpress.com

It comes down to personal preference where you draw the line. For us, only those stocks are allowed to appear on the heat map in our third step that seem attractively valued in both a short-term and long-term context. (We go back as far as 20 years, calculate averages and medians on different time frames and let our algorithm do the ruthless work.)

Step Three: The Heat Map of the most investable wide-moat stocks

Seeing the stocks of our shortlist on a heat map with a quality and valuation axis is something that can prove very useful when we need to make a decision on which candidates to analyze thoroughly. As explained in our previous article, we use the PRVit (Performance-Risk-Valuation investment technology) model of the EVA Dimensions team.

All in all, PRVit is a multifactor quantitative stock selection model based on EVA-centric measures of Performance, Risk, and Valuation. It first estimates the fundamental value of a company based on its risk-adjusted EVA performance (shown on the vertical axis) and then compares it to its actual valuation (shown on the horizontal axis). All factors in this model were chosen heuristically based on common sense, and not by data mining, yet strong and statistically significant backtests prove the soundness of the PRVit approach both in the U.S. and globally. (See the details here.)

Here is the heat map as of July 26:

Source: evaexpress.com

We also present the results in a table format to make your decision easier.

Source: evaexpress.com, Morningstar

(Stocks highlighted in light blue are Morningstar's 5-star-rated wide-moat names that survived the second step of our process.)

Each company has a composite 0-100 score in each category, where higher is better for Performance and lower is better for Risk and Valuation. We believe that stocks in the upper quintile of the PRVit ranking (with a PRVit score above 80) are worth a closer look.

I plan to run this three-step process on a monthly basis and publish the shortlist of targets it produces. Also, I am hopeful that the members of my FALCON Team will publish thorough analyses of the most promising targets. If you don't want to miss any of these pieces in the future, please scroll up and click "Follow" next to my name.

Disclosure: I am/we are long MO BRK.B KO ENB GILD PM RTX WFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.