By Brandon Rakszawski, VanEck Senior ETF Product Manager
The Morningstar® Wide Moat Focus IndexSM fired back strongly in November relative to the S&P 500 Index to erase a good portion of its 2020 relative underperformance. The Index posted a 15.01% return for the month vs. 10.95% for the S&P 500, leaving it trailing by 2.35% in 2020 thus far.
A large portion of underperformance in 2020 was “driven by poor relative returns in the summer months”: following the index’s shift toward oversold core and value-oriented stocks. Those moves were finally rewarded in November, after the U.S. presidential election, as values stocks began to starkly outpace growth-oriented stocks. Every one of the top 10 performing stocks in the Index in November were classified as either value or core stocks by Morningstar on November 30.
Tech (Yes, Tech) Standouts
A consistent theme of the last several years for the Index has been an underweight to tech stocks. Well, the tech sector was actually the strongest contributor to the Index’s November return. Four of the top 10 contributors to the Index performance came from the tech sector, from tech stocks that aren’t necessarily discussed at length on cable financial news each day.
Applied Materials (AMAT), a leading vendor of semiconductor fabricator tools, derives its wide economic moat from intangible assets around equipment expertise and research and development cost advantages. Morningstar considers it the top vendor in the semiconductor equipment market. AMAT reported quarterly results in Mid-November above management’s guidance and expressed an increase in guidance for next quarter as demand has remained strong in the face of uncertain economic conditions. Morningstar credits long-term trends in artificial intelligence, 5G and cloud computing for sustained demand. AMAT’s strongly positive November return (39.66%) erased its slightly negative 2020 returns through October, and Morningstar increased its fair value estimate to $74 per share from $65 mid-month based on the updated company outlook.
Microchip Technology (MCHP) also bounced back in a big way in November (28.26%), adding to its modest gains for the year prior to the month. Its quarterly results, released at the beginning of the month, provided confidence to investors, and management’s outlook painted a positive picture with expectations for “significant” revenue growth in 2021. MCHP is viewed by Morningstar as one of the best run firms in the chip space. It is a leading supplier of microcontrollers used in common electronics devices—think garage door openers, hands-free soap dispensers, electric razors, and many others. It benefits from both intangible assets (proprietary chip design) and switching costs (it is difficult to swap out its chips for competitive offerings). Morningstar increased MCHP’s fair value estimate to $118 from $108, and the company continues to trade well above that level after trading mostly below Morningstar’s fair value estimate since the end of 2017.
Guidewire Software (GWRE), a leading software provider to property and casualty insurers, posted the starkest reversal in November (27.44%), erasing a total return that was starkly negative through October. GWRE is deeply entrenched in the insurance market and benefits greatly from the switching costs source of moat. Being an industry that must constantly assess risk, insurance firms tend to be risk averse. This benefits the software provider to most of the industry, as most insurers are hesitant to make major changes to their operations. GWRE stock sold off following quarterly results in October but has since recovered and finished November trading at a nearly 10% premium to Morningstar’s fair value estimate.
Financials and Industrials Step Up
While the tech sector was the top contributing sector to November returns, several financials and industrials firms stood out as well.
Boeing Co. (BA) and Raytheon Technologies (RTX) were the second and fourth largest contributors to Index returns for the month, respectively. The two aerospace and defense companies were logical Index components in 2020 following significant declines in market prices that put both firms well below their Morningstar fair value estimates. Boeing, following its strong November (45.93%), is now trading at the closest it has traded to its fair value estimate since March of this year. It remains approximately 10% undervalued despite the strong tailwinds that accompanied positive COVID-19 vaccination prospects and signs of progress in its effort to get its 737 MAX airworthiness directive from the FAA. Raytheon also impressed during the month (33.01%) and now trades at a slight discount to Morningstar’s fair value.
Though I haven’t focused on financials here, the sector was the second leading contributor to Index returns in November. Standouts included American Express (AXP), Wells Fargo & Co. (WFC), and Charles Schwab Corp. (SCHW).
Few Detractors in November
g the news. Dominion Energy (D), the sole utilities company in the Index, was the other company to post a negative return in November with a return of -2.30%.
With a strong November in the book, we will continue to monitor the Index as it approaches its quarterly index review on December 18 to see where the Index identifies pockets of attractive valuations in the U.S. wide moat universe.
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