Morningstar Equity Research:

Methodology Overview and Ideas from Top Analysts in the

WSJs Best on the Street Survey
Heather Brilliant, CFA
Erin Davis International Banks
Brett Horn Business Services
Erin Lash Consumer Products

2013 Morningstar, Inc. All rights reserved.

<#>

Unique and Consistent Intrinsic Value Approach

Focus on business value, not what others will pay

We do primary research, formulating our own opinions by reading financial
filings & trade journals, visiting companies, talking to competitors & customers,
and attending industry conferences.
We have a long-term perspective backed by rigorous DCF models
We believe that competitive advantageseconomic moatsadd intrinsic
value, and we rigorously assess the competitive position
We believe that the ability of a business to generate ROIC above cost of
capital is the primary test of shareholder value creation
Intrinsic value principles work for both value and growth stocks
Consistent approach among analysts vs. varied fiefdoms of sell-side

Differentiated Approach to Ratings & Ratings Changes

Economic Moats Concept

Basic premise: Capitalism works

High profits attract competition

Competition reduces profitability

But some firms stay very profitable for a long time by creating economic moats
to protect profits

Economic moats are structural business attributes that help companies generate
high returns on capital for an extended period

Sustainable returns on capital are much more important than high returns on
capital

Crocs CROX or Nokia NOK vs. Kinder Morgan KMP or Union Pacific UNP

10-Year Return Shows Stark Difference Between NOK and KMP

Sources of Economic Moats

Intangible Assets | A Source of Moats

Intangibles that block competition and/or

allow companies to charge more

Brands:

Sony SNE vs. Tiffany TIF

Patents:

Pharmaceuticals

Licenses & Government Approvals

Corporate Culture:

Berkshire Hathaway BRK.B

Switching Costs | A Source of Moats

Time = Money, and vice versa

The cost of switching exceeds the expected

value of the benefit

Oracle ORCL

Autodesk ADSK

Praxair PX

Razor and blade models entrench repeat

consumables customers

Waters Corp WAT

ADT Corp ADT

The Network Effect | A Source of Moats

The Network Effect is present when the value

of a service grows as more people use a network.

With each additional node, the number

of potential connections in a network grows
exponentially

MasterCard MA, Visa V

eBay EBAY

Apple iOS AAPL (Apps)

Google Android GOOG (Apps)

CME Group CME (Financial Exchange)

Facebook FB

Cost Advantage| A Source of Moats

Allows firms to sell at the same price as

competition and gather excess profit
and/or have the option to undercut competition.

Economies of Scale:

United Parcel Service UPS (Distribution)

Sysco SYY (Distribution)

Intel INTC (Manufacturing)

Low-Cost Resource Base:

10

Ultra Petroleum UPL

Compass Minerals CMP

Efficient Scale | A Source of Moats

When a company serves a market limited in size,

new competitors may not have an incentive
to enter. New entrants would cause returns for
all players to fall well below cost of capital.

Natural Geographic Monopolies:

Airports

Pipelines

Niche markets:

Defense Companies

Graco GGG, Alexion ALXN, etc.

Rational Oligopolies

11

Canadian Banks

Measuring a Moat: ROIC is Key

A company that is likely to compound cash flow internally for many years is
worth more today than a company which isnt.
Look for ROIC > WACC for the next decade (Narrow) to two decades (Wide)
Duration of excess returns is far more important than absolute magnitude

Time
Horizon

12

Narrow Economic
Moat
ROIC

ROIC

Wide Economic
Moat

No Economic
Moat
ROIC

Time
Horizon

Time
Horizon

Why Moats Matter: Moats tell us about risk

Leverage
Wide

Liquidity
Wide

1.14

Narrow

Narrow

1.31

None

None

1.48

ROA

5.37M

Wide

9%
6%

Wide
Narrow

0.89

Narrow

3.06M

1.09

None

3.20M

Volatility

Wide
Narrow

CAPM Beta

1.29

Increased Likelihood
of Dividend Cut

19%
None

25%

2.5x

Narrow
None

None

2%

Market Cap
Wide

$51B

Narrow

$15B

32%

Wide

Narrow

1.0x

Increased Likelihood
of Bankruptcy

|Drawdown|
Wide

1.8x

23%
None

25%

53.0x

Narrow
None

13

$6B

None

32%

Wide

17.0x
1.0x

Morningstar Equity Research Performance

After another year of excellent performance, our Wide Moat Focus Index has now outgained
the S&P 500 by more than 600 basis points on an annualized basis since 2002 and
outperformed in seven of the last ten years.

Our Wide-Moat, 5-star stocks have generated an annualized return of over 19.72% since
2002.

Our ratings have generated exceptional performance over the long term. The Morningstar
Conviction Long Portfolio (composed of our 20 most under-valued and highest conviction
stocks) has returned over 17% annually since inception.

Thirteen Morningstar analysts were ranked as Master Stock Pickers by the Wall Street
Journal, the greatest number of ranked analysts among winning firms this year.

Morningstar Equity Research Performance Record

Trailing
1-Year*

Trailing
3-Year*

Morningstar Wide Moat Focus Index

16.76

12.85

12.34

13.67

Morningstar Tortoise

23.76

13.68

7.66

9.17

Morningstar Hare

17.03

12.02

7.82

11.27

Morningstar Dividend Builder

20.28

15.25

6.27

Morningstar Dividend Harvest

27.37

21.40

13.69

Buy at 5-star / Sell at 3-star

14.44

11.42

12.11

14.91

S&P 500 Index (cap-weighted)

16.90

12.80

5.21

7.88

Morningstar Large Cap Blend Mutual Fund Cat

15.65

10.86

4.09

7.15

Trailing Trailing
5-Year* 10-Year*

The Tortoise and Hare Portfolios have generated combined annualized returns of 8.38% vs. 4.37% for
the S&P 500, since 2001.
Time-weighted returns through 04/30/2013

* Annualized percentage returns

Source: Morningstar

Performance Record of Wide Moat Stocks

Morningstar
Rating

Since
Trailing
10-Year* Inception*
(26 Aug 2002)

Trailing
1-Year %

Trailing
3-Year*

Trailing
5-Year*

QQQQQ

31.87

20.27

16.54

20.71

19.72

QQQ

17.55

14.33

6.91

8.46

6.73

-1.73

7.33

-7.35

-2.13

-4.80

S&P 500
Index (cap-

16.90

12.80

5.21

7.88

7.23

weighted)

Time-weighted mean returns through 04/30/2013

* Annualized percentage returns

Source: Morningstar

Fiserv- A Wide Moat, Stability and Good Management

We think

a wide moat surrounds Fiservs primary product, due to high

switching costs. Recent replacement rates imply that the average bank
maintains its core processing system for over 30 years. Fiserv leverages
this essentially captive customer base to cross-sell ancillary products.

With

80-85% of revenue recurring, Fiserv benefits from a stable

revenue base.
% of Banks and Credit Unions Changing Core System
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
2006
Source: Automation in Banking, FDIC, NCUA

17

2007

2008

2009

2010

2011

Fiserv- A Wide Moat, Stability and Good Management

We think

stewardship has been exemplary. CEO Jeff Yabuki's cost

control results have been impressive, especially considering the
headwinds during the crisis.

While

slightly overvalued, we think Fiserv is a good stock to keep on

the radar in case of a pullback, and potentially a very attractive
defensive long-term holding.
Fiserv Adjusted Operating Margins
30.0%
29.0%
28.0%
27.0%
26.0%
25.0%
24.0%
2007

2008

2009

Note: Source: Company filings (margins exclude purchase amortization expense and one-time items).

18

2010

2011

2012

Sysco Poised to Serve Up Cost Savings and Share Gains

Sysco is the undisputed industry leader and has garnered a wide moat
with an expansive distribution network and 17.5% share of the highly fragmented
food-service distribution industry
Sysco has actively participated in the industry's consolidation, completing
more than 150 deals, and management's hunger for deals has yet to subside, with
acquisitions expected to contribute around 1% of sales growth each year.
Challenges stemming from sluggish restaurant traffic and food cost inflation persist,
but we still think Sysco should be well positioned when there is a more
consistent positive cadence to restaurant sales.
In a market where little looks overly appetizing, Sysco's shares strike us as
mildly tasty, as the market appears to be ignoring the breadth and depth of
Sysco's distribution network and product set.
Income investors should give the shares a look. The firm is committed to its
dividend, paying one each year since 1969 and targeting a payout ratio of 40%50%.

19

UBS New Strategy Builds on UBSs Moat

UBSs new strategy focuses its moaty private bank.
- The worlds largest private bank with CHF 1.7 tn of invested assets.
- Private banking customers tend to be sticky and not very price
sensitive
- ROE typically > 40%.
Scaling back on risky investment banking
- Closing sub-scale fixed-income trading desks
- Exiting businesses with excessive tail risk
- Targeting a 30% reduction in funded balance sheet
Best in class capital strength
- Fully applied Basel III equity tier 1 capital ratio = 10.1%
- Common tangible equity / tangible assets = 4.9%

Comprehensive Coverage

21

22