Since 2001 Morningstar has been rating stocks based on a Buffett-esque philosophy, including the usual Buffettisms like "moat" and "margin of safety".

In February they published a report card on how their ratings have been doing:

Here are the reported returns for their top ranked stocks*, along with the returns for the equal-weight S&P:

Mstar *The percentage returns for Morningstar are based on buying when a stock gets the highest rating, 5, and then selling when it falls to an "average" rating of 3.

A regression of Morningstar returns vs S&P Equal Weight returns gives:

(Morningstar return)=(-5.6%)+1.35*(S&P Equal Weight return)

In short, Morningstar was beaten by the S&P Equal Weight index in terms of both absolute return and risk-adjusted return.

I do like Morningstar. Their product is a really convenient and cheap way to get snapshot information on both stocks and mutual funds. I'm also impressed that they were honest and didn't try to bury this report, and that they compared upfront their returns with the S&P Equal Weight (rather than Cap-Weighted) Index. That is the appropriate benchmark for them because when they calculate their own performance, they weight their own picks equally, rather than by capitalization.

Still, it's yet another proof both that stockpicking is not easy, and that chanting Buffettisms (or even trying to apply them using a team of professional analysts) doesn't necessarily help.

Steve Leslie writes:

As I recall, Morningstar's 5 star rating system for mutual funds is backward-looking. They take the last three year returns and then break it into a quintile rating system. You are correct in that poorly performing funds can be victims of the style they employ rather than a reflection of their management skills and prospects going forward. Back in the 90s the 5 star funds were Van Waggoner, Aim, Janus and some of the really highly charged mutual funds everybody wanted these because of their raw numbers. Nobody wanted anything to do with value funds. The tables soon flipped and the high fliers fared very poorly in the bear market crash through 2003. Value funds took over, and then international funds. Interesting fact is that 80% of funds purchased are through a brokerage firm. Most likely due to the work involved in finding a mutual fund, evaluating it, and purchasing it. When I was a broker, we used Thomson Financial research as our database to evaluate funds. Schwab and Ibbotson have some pretty good mutualfund programs and tools as does Lipper. Kiplinger's Magazine is a good source to find quality mutual funds.

Sam Marx offers:

I like Morningstar because in all of their stock reviews they include a calculation of the stock's intrinsic value and indicate what type of moat the stock has.

Morningstar, however, is still in the last century when it comes to downloading their lists, such as screened items, portfolios, ranked stocks, etc., to Excel. Except for one very limited item no downloading to Excel is available.

Morningstar's attempt to cover options is very sparse.

Meanwhile their main competitor, Value Line, is excellent when it comes to covering options and downloading their lists to Excel. Value Line, however, needs an upgrade of the contents of their screen lists.





Speak your mind

5 Comments so far

  1. George Parkanyi on April 11, 2008 1:20 pm

    Moat - interesting. So how effective would one be during a long siege when you’re cut off from everything? How effective is it in the winter when it freezes? And if someone drops a stink-bomb or there is a fire inside, does everyone then drown while trying to escape?

    Would a moat have helped the Titanic?

    …I need to find something to do…


  2. Russell Sears on April 11, 2008 2:24 pm

    Charles, Is there an error in your Morning Star numbers? I get the average at 9.7% and the most the rounding error could be would make it 9.2%, not 8%.

  3. Alex Jones on April 12, 2008 8:43 am

    I don't know much about how they rate stocks, but their mutual fund ratings do frequently drop the funds of disciplined investors who have cycles of outperformance and underperformance at exactly the wrong time — namely at the end of a period of underperformance, when investors have the most to gain.

  4. Charles Pennington on April 12, 2008 11:36 am

    Yes, somehow I did list the wrong average for Morningstar. Should be 9.7% for Morningstar and 10.4% for S&P Equal Weight. Maybe the geometric averages are more relevant — 6.2% for Morningstar and 8.7% for S&P Equal Weight. Conclusion is the same — Morningstar's stock picks underperformed the equal weight market over the past seven years, and they had higher volatility and beta.

  5. gabe on April 12, 2008 11:37 am

    Looks like a cheap shot to me. You don't expect constant growth with low volatility if you use Buffet-isms. He never claimed this either. He is looking for 40 years, remember? the problem is these picks were made by analysts using what they consider moats etc. and if you read their research, some of these analysts are weak. Their CAGR for this period is about 6% which is dismal for seven years.


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