On a year-to-date basis, the 60 large companies that make up the S&P/TSX 60 Total Return Index have produced roughly a 5.4-per-cent return, mirroring the 15-year annualized return of the same index . This return to the black may provide investors with some relief, given that the same blue-chip index lost 6.3 per cent over the 2022 calendar year.
Recall that most Street analysts will value a company based on a projection of future cash flows or earnings, then will discount those cash flows back to present value to arrive at a fair value for the stock. This analysis is aptly named a discounted cash-flow model and is the basis of Morningstar’s own valuation methodology for stocks. The nuances of the model, namely the projected growth rate and the discount rate, influence the outcome greatly.
This is where Morningstar’s equity analysts’ expertise comes into play, particularly because they focus on a firm’s ability to keep competitors at bay – its economic moat, a term attributed to Warren Buffett.
Companies with wide moats are predicted by Morningstar to maintain competitive advantages for more than 20 years, while those with narrow moats are predicted to maintain advantages for 10 years. The concept of stock valuation and economic moat make a formidable combination, allowing investors to find competitive companies that may also look undervalued.
Today we screen the constituents of Canada’s blue-chip index to find companies that remain undervalued despite the recent positive performance of the index. To do so, we look for companies that have a Morningstar rating for stocks of four stars or better. Recall that Morningstar’s stock rating is a comparison between the stock’s current price and Morningstar’s fair-value estimate. Five-star stocks are considered undervalued, while one-star stocks are considered overvalued.
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