Morningstar Advisor - December 2013/January 2014 - (Page 71)

And PCF  10 While competitive advantages were an attractive starting point, we also wanted to ensure that the market wasn't placing a premium on those advantages. Our next step was to focus on valuation. We looked for firms that were trading at less than ten times their current cash flows. That cutoff reflects a discount to the price/cash flow levels for the sector and the broad stock market. And Morningstar Rating > 4 To expand on our valuation screen, we used the Morningstar Rating for stocks and searched for companies with at least a 4-star rating. A number of components drive this score including our estimate of the stock's intrinsic value based on a discounted cashflow model, the margin of safety we apply to our fair value estimates, and the current stock price relative to fair our value estimate. And Stewardship > Standard It is also pertinent for firms to be run by solid management teams whose interests are aligned with shareholders. Morningstar's Stewardship Rating represents our assessment of management's stewardship of shareholder capital, with particular emphasis on capital allocation decisions. Analysts consider companies' investment strategy and valuation, financial leverage, dividend and share buyback policies. Execution, compensation, related party transactions, and accounting practices are also factors that weigh on stewardship. We set the screen for a Stewardship Rating of either Standard or Exemplary. We ran this screen in October using Morningstar Direct. Here are the results. Western Union Company WU Western Union is the clear leader in an industry where size confers significant advantages. The money transfer business is scalable because the incremental costs of processing additional transactions are minimal. This gives Western Union a marked cost advantage over its rivals, and its operating margins are about twice that of its closest competitor. The Western Union brand is the most recognized in the industry and its network is unparalleled, which allows the company to maintain premium pricing. The company's size allows it to invest more heavily to maintain this advantage. The company's network of more than 500,000 agents creates a mild network effect. Each additional agent makes the Western Union network more attractive to other agents, as a wider network potentially draws more customers into their stores. Western Union has shown that it can maintain strong and durable relationships with its agents, as its top 40 agents have been with the company for 16 years, on average. PNC Financial Services Group PNC PNC's large, low-cost deposit base allows it to price loans competitively while still earning an attractive net interest margin. Deposits cost the bank about 18 basis points in the first quarter of 2013, which is low for a company with PNC's size and scale and half that of the national average of 39 basis points. Overall funding costs were 48 basis points, below the national average of 53. We expect this competitive advantage to prove enduring, as low-cost deposits tend to be sticky because of the hassle associated with changing bank accounts. Banco Santander Brasil SA/Brazil BSBR Santander Brasil is the smallest member of Brazil's lucrative six-bank oligopoly, which controls more than 90% of the system's assets. As with Itau Unibanco ITUB and Banco Bradesco BBD, we think Brazil's conservatively regulated and profitable banking system, along with the country's attractive demographics, will provide lush grounds for Santander Brasil to profitably grow in years to come despite the short-term challenges it faces. Grupo Santander STD, Spain's largest bank, remains the majority stakeholder of Santander Brasil, which we view as an advantage. In our opinion, the Brazilian subsidiary benefits from the well-run Spanish group's vast experience in integrations and expansions. A clear example is its massive integration with Banco Real, which was purchased from ABN AMRO in 2008. The integration has come a long way, with noticeable improvements in efficiency. Further, the Spanish bank's broad reach, particularly in Latin America, often makes Santander Brasil the institution of choice when Brazilian businesses need a bank to help them develop their operations beyond their native country. Wells Fargo & Co WFC We view Wells Fargo's dominant market position as its largest structural advantage. Following its purchase of Wachovia, Wells Fargo is now the largest deposit gatherer in major metropolitan markets such as San Diego, Phoenix, Denver, and Minneapolis, according to Thomson Reuters Bank Insight. In fact, we estimate that more than one third of the bank's deposits come from markets in which Wells Fargo is the pre-eminent player, and more than two thirds are gathered in markets in which the company ranks among the top three. Such positioning provides the bank's customers with unmatched convenience and provides the firm with a ready source of funds. In addition to boosting the top line, the bank's storied focus on cross-selling also deepens its customer relationships, increasing switching costs and adding to the bank's pricing power. Together, these factors result in more than $1 trillion in low-cost deposit funding, accounting for 70% of the company's funding and contributing to its narrow economic moat rating. Dan Wood is an equity research associate at Morningstar. MorningstarAdvisor.com 71 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014

Morningstar Advisor - December 2013/January 2014
Contents
Contributors
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster

Morningstar Advisor - December 2013/January 2014