Moat Stocks React to Inflation and Slowing Growth

April was a reset month for US equity markets, as investors digested persistent inflation data and declining GDP growth. It was the first negative month of the year, from a total return perspective, pausing what had been a consistent upward trajectory for US stocks to start the year. What did not change was the influence of a select few companies on returns. While Alphabet and Tesla were two of the few companies to contribute positively to S&P 500 Index returns, several of the “Magnificent 7” stocks led the market lower. Microsoft, Meta, Nvidia, and Amazon were four of the top five negative contributors to S&P 500 Index returns in April. This dynamic continues to make things difficult for differentiated, high active share strategies. This is especially true for those that aren’t typically focused on pockets of the market that have squeaked out success this year, such as energy stocks and subsets of the utilities and materials sectors.

The Morningstar Wide Moat Focus Index (the “Moat Index”) modestly lagged the S&P 500 Index in April, losing 4.96%. Driving this underperformance was stock selection, particularly from the health care and industrials sectors. For the year-to-date, it has been a story of stock selection across the board, both overweights and underweights. More on that below.

Down-market cap, smaller US companies suffered in April in the face of a higher-for-longer interest rate outlook. Higher rates mean potentially higher funding cost for smaller companies that may have less reliable cash flows than their larger peers. The Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) performed mostly in line with the Russell 2500 Index, representing the SMID cap market as a whole.

Smaller Caps Bear Brunt of Reset Month | As of 4/30/2024

Source: Morningstar. As of 4/30/2024. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index. Fund performance current to the most recent month end is available by visiting vaneck.com or by calling 800.826.2333.

Moat Index Highlights

Selection Drives Performance, Again

Stock selection has been the primary driver of relative performance since the Moat Index was launched in 2007. That continued in April and is the key driver of the short-term underperformance relative to the S&P 500 Index in 2024. The elephant in the room in 2024 is Nvidia. The Moat Index has not held Nvidia, which has been a notable headwind considering Nvidia alone has accounted for nearly 40% of the S&P 500 Index’s 2024 return thus far.

Health care companies Bristol-Myers Squibb (BMY) and Veeva Systems (VEEV) were notable underperformers in April. BMY shares suffered following mixed earnings results that were released near the end of the month. Despite the negative market sentiment, Morningstar maintained its $63 per share fair value estimate and believes the market is underestimating the strength of the firm’s next-generation drugs. Morningstar does acknowledge the magnitude of BMY’s patent cliff over the next five years. However, Morningstar believes the firm has enough new products to mitigate pressures from generics and maintains its wide economic moat rating.

VEEV, while in the health care sector, is very much a technology-oriented company. It is the leading provider of cloud-based software solutions specific to the life sciences industry, according to Morningstar. An unexpected departure of the company’s chief financial officer and principal financial officer was announced April 1, 2024, which drove market sentiment lower during the month. However, Morningstar believes the transition will not come with any significant operational disruptions and VEEV’s notable switching costs remain intact. VEEV shares currently trade at an approximately 25% discount to Morningstar’s fair value estimate.

Medtronic Downgrade

In late March, Morningstar stripped medical device manufacturer Medtronic PLC (MDT) of its wide economic moat rating. Moat rating downgrades from wide are rare and in the case of MDT’s, Morningstar’s concern is risk of material value destruction as opposed to deteriorating moat sources. Many medical device companies augment their internally developed innovation through M&A activities and MDT is no exception. However, their acquisition of Covidien has depressed returns on invested capital for a prolonged period, and Morningstar stands wary of additional value destruction risk through what is likely to be further industry consolidation. MDT is expected to work its way out of the Moat Index in the coming reviews.

Top Contributors and Detractors from Moat Index - April 2024

Source: Morningstar, April 2024. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

SMID Moat Index Highlights

The Good and the Bad Through a Difficult Environment

Following a strong performance month in March, SMID cap stocks finished well in negative territory in April, as the market digested inflation and growth data. Several stocks helped buoy returns for the SMID Moat Index during the period. Equitrans Midstream (ETRN) continued its strong performance following the announced acquisition by EQT in an all-stock transaction due to close in the fourth quarter of 2024. Morningstar sees the acquisition as a good deal for ETRN shareholders. Hasbro (HAS) also performed strongly in April after releasing impressive profitability figures toward the end of the month. The toy and game company completed its divestiture of eOne entertainment business, allowing profitability to swing significantly higher for the quarter. Morningstar maintained its $84 per share fair value estimate following the release and shares finished the month trading near a 25% discount according to Morningstar.

Trinet Group (TNET) was the leading detractor from SMID Moat Index returns in April. It provides outsourced payroll and human capital management services. Shares of TNET slid in late April after a challenging quarter in which higher insurance costs weighed on profitability. Despite the results, Morningstar maintained its $145 fair value estimate and narrow moat rating. CarMax (KMX) also negatively impacted SMID Moat Index returns as market sentiment soured after earnings were released in mid-April. Despite missing expectations for the quarter, Morningstar does not see CarMax as having a demand problem. Rather, it sees an issue of consumer affordability resulting from high interest rates on auto loans. Morningstar did reduce KMX’s fair value estimate from $135 per share to $125, but the company still trades at nearly a 50% discount to fair value.

Top Contributors and Detractors from SMID Moat Index - April 2024

Source: Morningstar, April 2024. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

Choose Your Moat Strategy

VanEck’s suite of moat investing strategies is powered by Morningstar’s equity research team, which seeks quality companies trading at attractive valuations. The below ETFs offer access to US moat companies:

VanEck Morningstar Wide Moat ETF (MOAT): companies with a wide moat rating, which means Morningstar believes the company is likely to sustain its competitive advantage for at least the next 20 years.

VanEck Morningstar SMID Moat ETF (SMOT): small and mid-cap moat companies.

Source for all data unless otherwise noted: Morningstar.