Wide-Moat Stocks On Sale - The October 2021 Heat Map

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.

ValeryEgorov/iStock Editorial via Getty Images

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 October 1, there were 175 wide-moat stocks meeting our criteria (unchanged compared to last month, as the upgrade of Chipotle Mexican Grill's (CMG) rating to wide-moat makes up for the deletion of Maxim Integrated, which was acquired by Analog Devices (ADI)).

Only 3.4% (6 stocks) of this wide-moat group earned a 5-star (most attractive) valuation rating. Here are they:

Company Name	Ticker
Yum China Holdings Inc	YUMC
Alibaba Group Holding Ltd	BABA
Anheuser-Busch InBev SA/NV	BUD
British American Tobacco PLC	BTI
Imperial Brands PLC	OTCQX:IMBBY
Tencent Holdings Ltd	OTCPK:TCEHY

Click to enlarge

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!)

Source: Data from Morningstar

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 October 1:

Company Name	Ticker
Altria Group Inc	MO
Amazon.com Inc	AMZN
Aspen Technology Inc	AZPN
Berkshire Hathaway Inc B	BRK.B
Biogen Inc	BIIB
Bristol-Myers Squibb Company	BMY
Campbell Soup Co	CPB
Coca-Cola Co	KO
Compass Minerals International	CMP
Constellation Brands Inc	STZ
Dominion Energy Inc	D
Enterprise Products Partners LP	EPD
Equifax Inc	EFX
Facebook Inc	FB
Gilead Sciences Inc	GILD
Intel Corp	INTC
Kellogg Co	K
Lockheed Martin Corp	LMT
Magellan Midstream Partners LP	MMP
Merck & Co Inc	MRK
Microsoft Corp	MSFT
Philip Morris International Inc	PM
Polaris Inc	PII
Salesforce.com Inc	CRM
The Western Union Co	WU
Wells Fargo & Co	WFC
Zimmer Biomet Holdings Inc	ZBH
ABB Ltd	ABB
Ambev SA	ABEV
Baidu Inc	BIDU
Bayer AG	OTCPK:BAYRY
Core Laboratories NV	CLB
GlaxoSmithKline PLC	GSK
Novartis AG	NVS
Reckitt Benckiser Group PLC	OTCPK:RBGLY
Roche Holding AG	OTCQX:RHHBY
Sanofi SA	SNY
Taiwan Semiconductor Manufacturing Co Ltd	TSM
Unilever PLC	UL
Westpac Banking Corp	WBK

Click to enlarge

All in all, we have 46 firms that pass our very first criteria. (Up from 31 a month ago.)

Source: Data from Morningstar

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.

32 of the 46 stocks survived this second step. Here's the list:

Company Name	Ticker
Alibaba Group Holding Ltd	BABA
Altria Group Inc	MO
Amazon.com Inc	AMZN
Ambev SA	ABEV
Anheuser-Busch InBev SA/NV	BUD
Aspen Technology Inc	AZPN
Baidu Inc	BIDU
Bayer AG	OTCPK:BAYRY
Berkshire Hathaway Inc B	BRK.B
British American Tobacco PLC	BTI
Campbell Soup Co	CPB
Coca-Cola Co	KO
Dominion Energy Inc	D
Enterprise Products Partners LP	EPD
Facebook Inc	FB
GlaxoSmithKline PLC	GSK
Imperial Brands PLC	OTCQX:IMBBY
Intel Corp	INTC
Kellogg Co	K
Lockheed Martin Corp	LMT
Merck & Co Inc	MRK
Novartis AG	NVS
Philip Morris International Inc	PM
Polaris Inc	PII
Reckitt Benckiser Group PLC	OTCPK:RBGLY
Roche Holding AG	OTCQX:RHHBY
Salesforce.com Inc	CRM
Sanofi SA	SNY
Tencent Holdings Ltd	OTCPK:TCEHY
The Western Union Co	WU
Westpac Banking Corp	WBK
Yum China Holdings Inc	YUMC

Click to enlarge

We are rather strict when it comes to historical valuation. There are stocks that unquestionably fail both or short- and long-term tests. 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. 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 October 1:

Source: Institutional Shareholder Services Inc.

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

Source: Institutional Shareholder Services Inc., Morningstar

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

In PRVit, the factors are grouped into three categories: Performance, Risk, and Valuation. 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.

We plan to run this three-step process on a monthly basis and publish the shortlist of targets it produces. Also, the members of the FALCON Team are publishing thorough analyses of the most promising targets.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BABA, TCEHY, KO, LMT, MO, PM either through stock ownership, options, or other derivatives. 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.

Comments

[hafen]

Great article! However, I can’t accept Imperial so high and EPD low. I’d love to feel comfortable owning IMBBY.

[mwh27]

@hafen I wouldn't touch tobacco with a 10-foot pole.

[Dollarsandcents]

@mwh27 ........ or companies controlled by the CCP

[hafen]

I understand, but the morality/health isn’t the issue. It’s rated quite high here, far higher than EPD, and I don’t see it.

[Nnnnnot So Smart]

Berkshire is cheap (~1.3 X Book) with a rock solid, fortress like, balance sheet. No accounting gimmickry, and they don't pay their management in shares. Buffett has been buying back shares annually at a +/- 5% annual clip. Even if you just buy and hold you will steadily own more and more of the company. What's not to like?

[Kmasse]

Really enjoy this article and excellent tables.

Could you please explain this quality score? Imperial Brands higher quality than Amazon?

[TDune75]

3 of the top 5 are Chinese equities. Very risky at this juncture as many SA contributors & commenters feel China is uninvestable. Other than those 3, some good stock picks identified in this article.

[BM Cashflow Detective]

$MO and $BTI have longer been among the best high yield stock opportunities.

Because an opportunity we're waiting for is usually already there.

[dldr]

EPD shows in the heat map as both poor quality and poor value. I can't wrap my head around that.

[big_prop]

Long BABA and continuing to add. The EVA monster!!

[RWilliam]

@big_prop baba is interesting to watch, I got in around the 200 week moving average currently ~200. I got out much higher. Xi is unpredictable, will he kill the golden capitalism goose? You have no rights unless you own baba through HK? China could just declare all companies state property. Just as England did after WW2 and destroyed the companies.

Long MO BTI PM EPD

Until baba takes back the 200 WMA I’d watch from the sidelines. If you have ridden it this far I would stay if not for the unpredictable nature China is currently.