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Morningstar: Investors Should Be Patient
Stock Analysis & Ideas

Morningstar: Investors Should Be Patient

Morningstar (MORN) is a company that provides independent investment research services worldwide. It provides its clients with many tools such as fundamental data and real-time global market data, just to name a few.

Although the company is fundamentally solid, we remain neutral due to its high valuation multiple.

Morningstar Creates Value for Shareholders

While profitability is what determines the viability of a business, not all profitability equates to value creation for shareholders. As a result, we like to use the economic spread to determine if a company is effectively allocating capital to its projects. The formula is as follows:

Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital

The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.

For Morningstar, the economic spread is a follows:

Economic Spread = 12.4% – 6.5%

Economic Spread = 5.9%

As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.

However, what is more important than the current economic spread is the company’s financial trends. Morningstar has seen steady growth in free cash flow over the past several years. In 2018, this figure was $238.7 million, which then increased to $254.4 million, $307.6 million, and $335 million in 2019, 2020, and the last 12 months, respectively.

In addition, gross margins have been on an upward trajectory, increasing from 56.9% in 2016 to 59.3% in the last 12 months. This suggests that the business is stable and predictable with a competitive advantage.

Dividends

For dividend investors, Morningstar is not a stock that is worth considering.

Morningstar currently has a 0.44% dividend yield, which is below the sector average of 1.68%. When taking a look at its LTM free cash flow figure of $335 million, its $53.4-million dividend payment looks safe.

Taking a look at its historical dividend payments, we can see that its yield range has trended downwards in the past several years.

At 0.44%, Morningstar’s dividend yield is near the low end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.

Investors looking for income would be better off holding one-year treasury bonds, which are currently yielding 0.76% and considered risk-free.

Valuation

Although a solid company, we have some concerns with Morningstar’s valuation. Currently, the EV/FCF ratio is 34.4x, which is higher than the historical average of 28.5x.

The reason why this is concerning is that we are in a tightening phase where interest rates are expected to increase. This will likely put pressure on valuations which would lead to a multiple contraction closer to the historical average.

With the stock currently down approximately 12.7% year-to-date, this correction to the historical average has already begun, and further downside may be likely.

TipRanks’ Smart Score Rating

According to TipRanks’ Smart Score rating system, Morningstar scores a 7 out of 10. Important to note in the image below is that insiders have been selling some shares over the past three months.

Although not significant amounts, it still demonstrates that insiders are not in any rush to add to their holdings.

In addition, the hedge fund activity shows that funds have been accumulating shares of Morningstar. However, that’s from the last quarter, and based on the year-to-date share price, it’s more likely that they have been sellers of the stock recently.

Final Thoughts

Morningstar is an interesting company with strong fundamentals. However, the current valuation warrants caution from investors as interest rates continue to rise.

As a result, we will be keeping an eye on the stock to see if it can reach more attractive valuation levels going forward.

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