Morningstar Advisor - June/July 2012 - (Page 45)

Under the new methodology, which places a much greater emphasis on strategic decisions, investments, and other actions that concretely affect shareholder value, Ford management’s wise moves partially offset the concern of the dual share-class structure. Therefore, we award the firm a Standard rating. Alan Mulally joined Ford in 2006 as CEO and the changes he made allowed the company not only to survive the global financial crisis but also to thrive as a highly profitable automaker. In particular, Mulally’s financing moves in 2006 helped Ford weather the downturn without any taxpayer-funded bailout money. After Mulally’s product moves, Ford started making cars people wanted. Mulally also put in place significant manufacturing efficiencies and improved product quality. The Specifics Exemplary rating because of its managers’ wise investment decisions from both a strategic and valuation perspective. Eldorado is one of only two companies in our gold mining coverage universe that has earned an economic moat, which is largely attributable to CEO Paul Wright and his management team amassing a portfolio of low-cost, long-life mining assets without paying an arm and a leg in terms of capital spending. Wright has accomplished this by focusing on under-theradar mining jurisdictions such as China, Turkey, and Greece (where the competition for quality mining assets is less intense), as well as through prudent capital allocation. Financial Leverage A company’s strategy with regard to financial leverage can have a big impact on shareholder returns, uncertainty, and volatility. Analysts look unfavorably on cyclical, capital-intensive companies that carry a high debt load. Likewise, mature, stable companies with minimal reinvestment needs that sport too little debt are clearly not doing everything to maximize shareholder value. We unfavorably view stewardship at basic-materials companies such as Vulcan Materials VMC, Alpha Natural Resources ANR, and Arch Coal ACI—who each leveraged up to purchase peers during peak industry conditions. Shareholders suffered the negative consequences of too much financial leverage. Dividend and Share-Buyback Policies Dividends and share repurchases are used to return cash to shareholders. Just like with financial leverage, a Morningstar analyst is like Goldilocks, looking for an ideal amount of returning cash to shareholders that’s neither too little nor too much for a particular company. A company with many opportunities to invest cash at high rates of return within the business or even with acquisition opportunities should probably de-emphasize dividends and share repurchases. Meanwhile, a mature company with minimal profitable investment opportunities should look to return cash to shareholders. Execution A robust portfolio of attractive operating assets and skilled human capital, assembled with favorable valuations, can’t create shareholder value if a company has frequent operational and execution missteps. Industrial accidents, customer service problems, or product recalls can depress operational results and destroy shareholder value. Conversely, praiseworthy execution can lead to a company significantly outperforming its peers on operational metrics and shareholder value creation. Chubb Corp. CB, for example, earns an Exemplary rating. Chairman and CEO John Finnegan has been at the helm since 2002 and, along with the rest of his management team, has done an exemplary job in his stewardship of shareholders’ capital. Before Finnegan’s tenure, Chubb was consistently losing money on underwriting, a trend that was sharply reversed by the decisions and policies put into place by current management. Chubb refocused its business on the most profitable and moaty businesses. Furthermore, it is now a much more disciplined company in terms of underwriting margins. While on the surface it seems obvious that insurers should consistently strive for profitable underwriting, there are many pressures that cause companies to cut prices, especially during the competitive periods in soft pricing markets. Chubb has largely managed to avoid these temptations, a testament to management’s quality. Chubb is now among the most profitable underwriters of the insurance companies we cover. Compensation In most cases, a company’s compensation practices will not materially affect our Stewardship Rating for stocks. However, egregious compensation can keep an otherwise admirable management team from earning an Exemplary rating. In certain cases where compensation is especially outrageous, where a material amount of value is being directed to managers at the expense of owners, companies can receive a Poor rating. We look Here is a breakdown of what Morningstar’s analysts will examine when determining a company’s Stewardship Rating. Investment Strategy Given Morningstar’s focus on competitive dynamics, analysts pay close attention to a company’s investment strategies. A key question for all companies is, Has the firm strayed from core competencies in the pursuit of growth? A company with exemplary stewardship will be one that has made investments and acquisitions that support its competitive advantages and core businesses. Moreover, exemplary firms will divest underperforming or non-core businesses. Express Scripts ESRX earns an Exemplary Stewardship Rating, for example, because the company’s acquisitions of NextRx and Medco strengthened its existing competitive advantages. Investment Valuation Unfortunately, investments that make sense from a strategic perspective can still destroy shareholder value if the price paid is too high. Therefore, analysts consider the price of acquisitions and the cost of major investments. For example, Eldorado Gold EGO has an MorningstarAdvisor.com 45 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2012

Morningstar Advisor - June/July 2012
Contributors
Letter From the Editor
Be Worth Remarking About
How Important Is Stewardship?
From West Point to Points East
Where a Fund’s Secrets Lie
Getting Fund Directors on Board
Managers Prep for Housing Rebound
Four Picks for the Present
Investment Briefs
A Hedge Against Career Risk
Natural Gas Reaches Capitulation
Family Matters
How Good Stewardship Predicts Superior Performance
Stewardship Goes Back to the Fundamentals
On the Go for Fixed Income
Where Shareholders Ride First Class
Dangers Lurk in Exchange-Traded Notes
Stocks on Sale in a Strong Market
A Good Steward Is Easy to Find
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
Buffett Rule’s Biggest Losers

Morningstar Advisor - June/July 2012