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1.
What does Morningstar prefer to use to value stocks?
Future profits. Using future profits is easier to understand and requires less context than using ratios.
2.
Which generally takes more time and expertise to calculate?
Future cash flows. These require a lot of financial statements, facts, and projections to calculate.
3.
The Morningstar Fair Value Estimate represents which of the following?
An estimate of how much a stock should be worth today based on how much cash flow the company is expected to generate in the future. Morningstar's Fair Value Estimate represents how much a stock should be worth today based on how much cash flow the company is expected to generate in the future. The Morningstar Fair Value Estimate should not be confused with a target price, which is how much the market might be willing to pay for a stock. To arrive at a fair value, Morningstar analysts use a detailed discounted cash-flow model that factors in projections for the company's income statement, balance sheet, and cash-flow statement. It is not adding projected earnings growth to a stock's current trading price.
4.
How would a tiny change in a stock's price change its Morningstar Rating?
It likely would not change it. There is a buffer zone built into the ratings to prevent tiny changes from leading to a new rating.
5.
Five-star stocks should generate a return _______.
Greater than the company's cost of equity. Five-star stocks should offer investors a return that is greater than the company's cost of equity. The cost of equity is often called the "required return," because it represents the return an investor requires for taking on the risk of owning a stock. Since 5-star stocks are considerably undervalued, we expect investors will enjoy high returns that significantly exceed the risks associated with investing in the stock.
