Moat Stocks Review: Navigating Bonds, Beauty and Battleships

U.S. equity markets exhibited mixed performance in October. Major indices briefly reached new all-time highs, before pulling back due in part to anticipation around the closely contested U.S. presidential election. The market movements were influenced by a mix of corporate earnings, economic data, and the potential policy implications of the election outcome. Despite some volatility towards the month's end, investor sentiment remained cautiously optimistic. The prospect of policy adjustments from the incoming administration added to the market's dynamics, though it was clear that traditional economic fundamentals like employment figures and inflation rates continued to play significant roles in investor decision-making.

After a strong third quarter, where the Morningstar Wide Moat Focus Index (the “Moat Index”) gained 12.1% compared to the S&P 500’s 5.8%, the Moat Index took a breather in October as it trailed the broader market. Sector allocation was the primary driver of underperformance during the month, as overweights in health care, industrials and consumer defensives detracted the most from performance. Quarterly earnings-related volatility in a few wide moat names also detracted. Year-to-date, the Moat Index, as well as most other segments of the equity market, remain laggards to an S&P 500 that has been dragged up by the dominance of mega-cap technology.

Down market-cap, smaller companies also fell in October with the small- and mid-cap benchmarks down 2.6% and 0.7% during the month, respectively. The Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) fared slightly better, falling only about half a percentage point. The SMID Moat Index’s October outperformance was predominantly the result of strong stock selection by the strategy. Despite their relative underperformance the last few years, future prospects for SMID-caps appear to be improving.

Equities Choppy Leading into U.S. Elections

Source: Morningstar. Data as of 10/31/2024. 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: Bonds, Beauty and Battleships

Sector allocations were the primary driver of performance in October, with overweights in health care, industrials, and consumer defensive sectors having the greatest negative impact. Volatility in quarterly earnings among some wide moat companies also detracted during the month. However, bright spots within the Moat Index remained and helped to offset this.

In the top slot of the contributors table this month is the wide moat MarketAxess (MKTX). MarketAxess is a leading electronic trading platform that connects broker-dealers and institutional investors. The company is primarily focused on credit based fixed income securities, with its main trading products being U.S. investment-grade and high-yield bonds as well as emerging market corporate debt. Morningstar believes that MarketAxess is well-positioned to benefit from the transition away from voice-negotiated trading toward electronic platforms, creating strong tailwinds for continued revenue growth. MKTX saw its share price rise nearly 13% in October to end the month around $290 per share, which still falls below Morningstar’s $305 estimate of fair value.

The two largest detractors during the month were both related to volatility surrounding earnings as Estee Lauder (EL) and Huntington Ingalls (HII) both saw notable declines in the final days of the month following their quarterly releases. The global personal care and beauty product company Estee Lauder posted decent results with a beat on earnings per share, but signaled some uncertainty in forward guidance around sales growth in China. Morningstar adjusted their estimate of fair value down to $162 from $176 following the update, but still views shares as deeply undervalued at a 50% discount and continues to see a path to growth over the medium term as the macro backdrop brightens.

Huntington Ingalls (HII), a wide moat independent military shipbuilder responsible for supplying the U.S. Navy with destroyers and nuclear submarines, also saw near-term earnings-related volatility following prolonged contract negotiations with the Navy. However, Morningstar remains optimistic about Huntington Ingalls given its 40% discount to their fair value estimate and that Huntington is one of only two major shipbuilders for the U.S. Navy, which has a vested interest in maintaining the financial viability of the company.

Top Contributors and Detractors from Moat Index - October 2024

Leading Contributors

Leading Detractors

Source: Morningstar, October 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: Cruise Liners Chart Success

The SMID Moat Index’s lead over small- and mid-cap broad benchmarks in October was driven by favorable stock selection rather than sector over or underweights. Sailing ahead of the pack this month were two cruise line operators, Norwegian Cruise Line (NCLH) and Carnival (CCL) as both names gained around 20% in October. With pandemic-related changes in consumer behavior around travel well behind, Morningstar views these cruise liners as on a path to generate excess economic rents going forward. This optimism is reflected in Morningstar’s fair value estimates for NCLH and CCL, $31.50 and $28.00, respectively, which indicate room for further advancement in share price for both.

Also positively contributing to the SMID Moat Index’s performance in October was the mid-cap financial services and investment advisory firm LPL Financial (LPLA). Following a strong earnings release that saw the recruitment of new assets and ongoing retention and monetization of existing assets, shares of LPLA soared to end the month up 20%. Morningstar noted that they don't anticipate making a significant change to their $314 per share fair value estimate following the update, and that they assess shares as being fairly valued to modestly undervalued.

Names that detracted most from SMID Moat Index performance during the month include the aforementioned shipbuilder Huntington Ingalls, the government-sponsored healthcare plan focused managed care organization Centene (CNC), health diagnostics and research company IQVIA Holdings (IQV), semiconductor equipment and materials company Teradyne (TER), and toy and game company Hasbro (HAS).

Top Contributors and Detractors from SMID Moat Index - October 2024

Leading Contributors

Leading Detractors

Source: Morningstar, October 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 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.