Moat Strategies Gain on Strong Stock Selection

In August, U.S. equity markets moved higher, driven by expectations of Federal Reserve rate cuts following Chairman Jerome Powell's commentsat Jackson Hole. Powell's indication of policy adjustment, hinting at a shift from combating inflation to supporting economic growth, spurred a continuation of the market rotation from tech giants towards value stocks. This shift was underpinned by a cooling job market and controlled inflation, setting the stage for potential rate cuts, potentially as soon as the Fed's September meeting. The market's reaction showcased a broadening of gains, reflecting optimism in policy easing and continued economic resilience, despite geopolitical tensions.
 
The Morningstar Wide Moat Focus Index's (the "Moat Index") strong July carried over into August. Driving this outperformance was strong stock selection and supportive sector allocations with overweights in the consumer defensive and healthcare segments. Year-to-date, the Moat Index trails the S&P 500, given its value bias and structural underweight to mega-caps. However, the performance gap has narrowed considerably in the last two months, as market dynamics shift away from big tech and toward more value-oriented areas.
 
Smaller U.S. companies took a breather in August following their remarkable rally in July that saw small- and mid-cap indexes rise as much as 10%. The Morningstar US Small-Mid Cap Moat Focus Index (the "SMID Moat Index) still found pockets of growth within the cohort, while the broader benchmark indexes were down slightly. The SMID Moat Index's August outperformance was predominantly the result of favorable stock selection rather than sector over or underweights.
 

Moat Stock Outperformance Continued in August

Moat Index Highlights: Cybersecurity and Coffee Boost Moat Index

Strong stock selection within the Moat Index was the primary driver of relative performance versus the S&P 500 in August with cybersecurity and coffee providing a boost. Favorable sector allocation was also additive during the month with overweights in consumer defensive and healthcare contributing as well as an underweight to technology.
 
In the top slot of the contributors table this month is wide moat company Fortinet (FTNT). Fortinet is a leader in the security space with solutions ranging from network security firewalls to security operations. Morningstar believes that Fortinet's platform approach to cybersecurity, which combines key aspects of a business' security needs under one umbrella, has enabled the firm to grow its wallet share among existing clients while adding new ones. This approachled to a strong second quarter earnings release that saw revenue and profitability surpass expectations, sending Fortinet shares up over 30% during the month.
 
Also landing in the top contributors table this month is one of the world's most widely recognized restaurant brands, Starbucks (SBUX). Shares of Starbucks exploded higher on news that the specialty coffee chain had lured Brian Niccol to head the company as new CEO. Niccol comes with a sterling restaurant industry track record from his time as CEO at the wide moat burrito chain Chipotle and the Mexican-inspired fast-food chain Taco Bell. Investors sent a strong message that leadership matters as shares of Starbucks finished up over 20% in August.
 
Names detracting from the Moat Index this month include the e-commerce marketplace operator Etsy (ETSY), global beauty products seller Estee Lauder (EL), drug manufacurer Pfizer (PFE), aerospace and defense company Boeing (BA), and industrial equipment and software business Emerson Electric (EMR).
 

Top Contributors and Detractors from Moat Index - August 2024

SMID Moat Index Highlights: Dashing Ahead on Stock Selection

The SMID Moat Index's lead over small- and mid-cap broad benchmarks in August was driven by favorable stock selection rather than sector over or underweights. Leading the pack of SMID moat companies in August was the mid-cap food order aggregator and delivery company DoorDash (DASH). DoorDash released strong earnings at the beginning of the month, boasting quarterly records for key metrics like total orders and gross order value. Shares of DASH finished up over 16% during the month. Longer term, Morningstar expects international opportunities, increased penetration in new verticals such as grocery, and an uptick in advertising sales to support top-line growth for DASH.
 
Also contributing to the SMID Moat Index's performance in August was the wide moat healthcare information services company Veeva Systems (VEEV). Veeva is the leading provider of cloud-based software solutions tailored to the life sciences industry. It provides an ecosystem of products to address the operating challenges and regulatory requirements that companies in the space face. Veeva reported solid second-quarter results that came in above expectations with the firm demonstrating strong performance throughout the customer size spectrum with wins from both large pharmas and small biotech, sending shares up 12% during the month. Despite this rise, Morningstar's estimate of fair value for VEEV is $273 per share, indicating upside potential remains.
 
Names that detracted most from SMID Moat Index performance during the month include the specialty industrial machinery company Chart Industries (GTLS), home fragrance and body care retailer Bath & Body Works (BBWI), alternative asset manager The Carlyle Group (CG), drug discovery and development services company Charles River Laboratories (CRL), and regional automobile dealership Abury Automotive Group (ABG).
 

Top Contributors and Detractors from SMID Moat Index - August 2024

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