morningstar equity research product guide...page 2 of 11 morningstar ® equity research product uide...

Morningstar® Equity Research Product Guide This guide provides a summary of the Morningstar Equity Research now available at Schwab.

ContentsMorningstar RatingTM

Equity Analyst Report Sector ReportMorning NotesPick ListsAnalyst Insight Articles Analyst VideosWeekly Research Highlights Quarterly Market Outlook

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Morningstar, Inc. is a leading provider of independent equity, credit, manager and markets investment research in North America, Europe, Australia, and Asia. Our combination of bottom-up research and top-down economic theory generates an unparalleled perspective on the global investing environment. We are distin-guished by the depth and breadth of our coverage, our transparent methodology, and our investor focus.

Morningstar’s equity research team, in particular, is comprised of 120 analysts covering more than 1,400 companies to highlight companies they consider to be quality investments. Stocks rated highly by our equity analysts have consistently outperformed the broader market over the long-term: Our proprietary Morningstar Wide Moat Focus IndexSM — which buys the 20 cheapest wide-moat stocks in our universe each quarter — has outperformed the S&P 500 by over 6% annually since its inception in 2002, as of June 2014.*

*Reflects correct performance statistics as of June 30, 2014.

Morningstar® Equity Research Product Guide of 11

The Morningstar Rating™

Use the Morningstar Rating for stocks to quickly see if a company is worth the price that the market is asking for its shares. The star rating represents our opinion of the firm’s intrinsic value relative to its market price.

Brian Colello, CPA, 22 July 2014

Investment ThesisWe believe Apple's strength lies in its experience andexpertise in integrating hardware, software, services, andthird-party applications into differentiated devices thatallow Apple to capture a premium on hardware sales.Although Apple has a sterling brand, strong productpipeline, and ample opportunity to gain share in its variousend markets, short product life cycles and intensecompetition will prevent the firm from resting on itslaurels, or carving out a wide economic moat, in ouropinion.

We believe Apple has developed a narrow economicmoat, thanks to switching costs related to many attributesaround the iOS platform that may make current iOS usersmore reluctant to stray outside the Apple ecosystem forfuture purchases. In our view, much of Apple's exponentialgrowth in recent years has stemmed not from the firm'seconomic moat, but from the achievement of building thefirst truly revolutionary smartphone, the iPhone, thatintegrated hardware and software, as well as a robustapps store and ecosystem that attracted new users toplatform. Apple's first-mover advantage may bediminishing, and "easy growth" coming from earlysmartphone adopters may be winding down as thesmartphone market moves up the adoption curve andcompetition ramps up. Yet we still foresee iPhone growth,coming from both attracting new customers to iOS (mostlyin emerging markets, although we still see U.S. growthas well) and retaining Apple's existing premium iPhonecustomers, where we think the company's moat will playan increasingly important role. A partnership with ChinaMobile, the world’s largest wireless carrier, should alsogive iPhone growth a shot in the arm.

Ultimately, we think future smartphone and tabletcompetition will stem from software and services, ashardware is already approaching commoditization. Weview Apple as well positioned to develop and expandenough services to enhance the user experience, in orderto build switching costs that will help the firm retaincustomers and generate significant repeat purchases willbe critical for future iPhone growth in the years ahead.


Apple is driving software and services innovation to capture premiumpricing on hardware.

Bulls Say

OSmartphones should continue to grow as apiece of the total handset pie. This bodes well forfuture iPhone sales.

OApple's iPhone and iOS operating system haveconsistently been rated at the head of the pack interms of customer loyalty, engagement andsecurity, which bodes well for the firm's ability toretain customers in the long-term.

OFor each iOS device purchased, customers maybe less likely to switch to another provider andmore likely to buy repeat Apple products, whichwe view as a good sign for long-term hardwareand iTunes revenue.

Bears Say

OApple’s recent decisions to maintain a premiumpricing strategy may help fend off gross margincompression but may also limit unit sales andmarket share as the low end of the smartphonespace will likely grow faster than the premiummarket.

OWhereas Apple focuses on a handful of keyproducts, Samsung has emerged as a strong rivalby offering highly competitive devices of all sizesand prices at all times of the year.

OSome may question whether Apple has lostmuch of its vision and creativity with the passingof cofounder Steve Jobs in October 2011.

Morningstar Pillars Analyst Quantitative

Economic Moat Narrow WideValuation QQQ OvervaluedUncertainty High MediumFinancial Health AA- Strong

Current 5-Yr Avg Sector Country

Price/Intrinsic Value 1.07 0.93 1.02 1.00Price/Earnings 16.0 15.2 21.1 20.8Forward P/E 14.0 — 15.0 15.3Price/Cash Flow 10.9 11.3 13.3 12.4Price/Free Cash Flow 12.8 13.2 18.4 20.8Dividend Yield % 1.79 — 1.61 1.97

Analyst NoteApple reported solid third-quarter earnings, and gaveinvestors a fourth-quarter outlook that was relatively inline with our expectations. However, the bigger storycontinues to revolve around buzz for the company’supcoming products (iPhone 6, new iPads, and a possibleiWatch). Management has set a bullish tone for its productpipeline and for revenue growth this holiday season. Weexpect to maintain our $87 fair value estimate, and Apple'snarrow economic moat rating.

Apple’s $37.4 billion in quarterly revenue modestly trailedexpectations, as it failed to reach the high end of itspreviously forecasted range of $36 billion to $38 billion.IPhone unit sales of 35.2 million were a shade below ourexpectations, but still relatively strong. iPad unit sales of13.3 million were down 9% from the year-ago quarter,mainly due to soft sales in developed markets. However,Mac sales and iTunes revenue grew nicely, as did revenuefrom China (iPhone, iPad and Mac sales in the region wereup 48%, 50%-plus and 39% from the year-ago quarter,respectively). Favorable component pricing helped Appleearn a healthy 39.4% gross margin, above expectations.Apple projects revenue of $37 billion to $40 billion in theSeptember quarter, which we think implies modest iPhoneunit sales growth, to the mid-to-high 30 million unit range.

Management was upbeat about its product pipeline andgrowth opportunities for the critically important holidayseason. One concern around iPhone growth stems fromchanges to wireless carrier plans in the U.S., but Applecommented that programs like AT&T Next, which allowfor early upgrades, are a net positive for the firm. Applealso expects to revitalize iPad demand with productenhancements. Combined with ongoing traction at ChinaMobile and reports that the firm is asking its suppliers tobuild over 70 million new iPhones for its impending launch,Apple may be well positioned for hearty sales growth laterthis year.

Economic Moat Brian Colello, CPA 22 July 2014

We believe Apple has a narrow economic moat based onmodest, but not insurmountable, customer switchingcosts. We don't believe these switching costs are criticalfactors in attracting new iOS customers, especially in

Source: Morningstar Equity Research

Source: Morningstar

Undervalued Fairly Valued Overvalued

Quantitative Valuation

aUSA

AAPL

Morningstar Equity Analyst Report | Report as of 29 Jul 2014 | Page 1 of 12

Apple Inc AAPL (XNAS)Morningstar Rating Last Price Fair Value Estimate Price/Fair Value Dividend Yield % Market Cap (Bil) Industry Stewardship

29 Jul 2014 29 Jul 2014 29 Jul 2014 29 Jul 2014QQQ 98.38 USD 87.00 USD 1.13 1.79 589.09 Consumer Electronics Standard

© 2014 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information containedherein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited withoutwritten permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869. See last page for important disclosures.

?

Price/Fair Value

2.75

2.50

2.25

2.00

1.75

1.50

1.25

1.00

0.75

0.50

0.25

Low Medium High Very High*

* Occasionally a stock’s uncertainty will be too high for us to estimate, in which case we label it Extreme.

• 5 Star

• 4 Star

• 3 Star

• 2 Star

• 1 Star

Uncertainty Rating

— 125%

105% —

80% —— 95%

— 135%

110% —

70% —

— 90%

— 155%

115% —

60% —

— 85%

— 175%

125% —

50% —

— 80%

Ratios of Price to Fair Value Estimate Corresponding To Morningstar Equity RatingsMorningstar Star Rating Bands as of August 18, 2011


Investment ThesisWe believe Apple's strength lies in its experience andexpertise in integrating hardware, software, services, andthird-party applications into differentiated devices thatallow Apple to capture a premium on hardware sales.Although Apple has a sterling brand, strong productpipeline, and ample opportunity to gain share in its variousend markets, short product life cycles and intensecompetition will prevent the firm from resting on itslaurels, or carving out a wide economic moat, in ouropinion.

We believe Apple has developed a narrow economicmoat, thanks to switching costs related to many attributesaround the iOS platform that may make current iOS usersmore reluctant to stray outside the Apple ecosystem forfuture purchases. In our view, much of Apple's exponentialgrowth in recent years has stemmed not from the firm'seconomic moat, but from the achievement of building thefirst truly revolutionary smartphone, the iPhone, thatintegrated hardware and software, as well as a robustapps store and ecosystem that attracted new users toplatform. Apple's first-mover advantage may bediminishing, and "easy growth" coming from earlysmartphone adopters may be winding down as thesmartphone market moves up the adoption curve andcompetition ramps up. Yet we still foresee iPhone growth,coming from both attracting new customers to iOS (mostlyin emerging markets, although we still see U.S. growthas well) and retaining Apple's existing premium iPhonecustomers, where we think the company's moat will playan increasingly important role. A partnership with ChinaMobile, the world’s largest wireless carrier, should alsogive iPhone growth a shot in the arm.

Ultimately, we think future smartphone and tabletcompetition will stem from software and services, ashardware is already approaching commoditization. Weview Apple as well positioned to develop and expandenough services to enhance the user experience, in orderto build switching costs that will help the firm retaincustomers and generate significant repeat purchases willbe critical for future iPhone growth in the years ahead.


Apple is driving software and services innovation to capture premiumpricing on hardware.

Bulls Say

OSmartphones should continue to grow as apiece of the total handset pie. This bodes well forfuture iPhone sales.

OApple's iPhone and iOS operating system haveconsistently been rated at the head of the pack interms of customer loyalty, engagement andsecurity, which bodes well for the firm's ability toretain customers in the long-term.

OFor each iOS device purchased, customers maybe less likely to switch to another provider andmore likely to buy repeat Apple products, whichwe view as a good sign for long-term hardwareand iTunes revenue.

Bears Say

OApple’s recent decisions to maintain a premiumpricing strategy may help fend off gross margincompression but may also limit unit sales andmarket share as the low end of the smartphonespace will likely grow faster than the premiummarket.

OWhereas Apple focuses on a handful of keyproducts, Samsung has emerged as a strong rivalby offering highly competitive devices of all sizesand prices at all times of the year.

OSome may question whether Apple has lostmuch of its vision and creativity with the passingof cofounder Steve Jobs in October 2011.


Economic Moat Narrow WideValuation QQQ OvervaluedUncertainty High MediumFinancial Health AA- Strong


Price/Intrinsic Value 1.07 0.93 1.02 1.00Price/Earnings 16.0 15.2 21.1 20.8Forward P/E 14.0 — 15.0 15.3Price/Cash Flow 10.9 11.3 13.3 12.4Price/Free Cash Flow 12.8 13.2 18.4 20.8Dividend Yield % 1.79 — 1.61 1.97

Analyst NoteApple reported solid third-quarter earnings, and gaveinvestors a fourth-quarter outlook that was relatively inline with our expectations. However, the bigger storycontinues to revolve around buzz for the company’supcoming products (iPhone 6, new iPads, and a possibleiWatch). Management has set a bullish tone for its productpipeline and for revenue growth this holiday season. Weexpect to maintain our $87 fair value estimate, and Apple'snarrow economic moat rating.

Apple’s $37.4 billion in quarterly revenue modestly trailedexpectations, as it failed to reach the high end of itspreviously forecasted range of $36 billion to $38 billion.IPhone unit sales of 35.2 million were a shade below ourexpectations, but still relatively strong. iPad unit sales of13.3 million were down 9% from the year-ago quarter,mainly due to soft sales in developed markets. However,Mac sales and iTunes revenue grew nicely, as did revenuefrom China (iPhone, iPad and Mac sales in the region wereup 48%, 50%-plus and 39% from the year-ago quarter,respectively). Favorable component pricing helped Appleearn a healthy 39.4% gross margin, above expectations.Apple projects revenue of $37 billion to $40 billion in theSeptember quarter, which we think implies modest iPhoneunit sales growth, to the mid-to-high 30 million unit range.

Management was upbeat about its product pipeline andgrowth opportunities for the critically important holidayseason. One concern around iPhone growth stems fromchanges to wireless carrier plans in the U.S., but Applecommented that programs like AT&T Next, which allowfor early upgrades, are a net positive for the firm. Applealso expects to revitalize iPad demand with productenhancements. Combined with ongoing traction at ChinaMobile and reports that the firm is asking its suppliers tobuild over 70 million new iPhones for its impending launch,Apple may be well positioned for hearty sales growth laterthis year.

Economic Moat Brian Colello, CPA 22 July 2014

We believe Apple has a narrow economic moat based onmodest, but not insurmountable, customer switchingcosts. We don't believe these switching costs are criticalfactors in attracting new iOS customers, especially in


Source: Morningstar



aUSA

AAPL

Morningstar Equity Analyst Report | Report as of 29 Jul 2014 | Page 1 of 12

Apple Inc AAPL (XNAS)Morningstar Rating Last Price Fair Value Estimate Price/Fair Value Dividend Yield % Market Cap (Bil) Industry Stewardship

29 Jul 2014 29 Jul 2014 29 Jul 2014 29 Jul 2014QQQ 98.38 USD 87.00 USD 1.13 1.79 589.09 Consumer Electronics Standard


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Morningstar Equity Analyst ReportEquity Analyst reports examine each company’s worth and related investment considerations, providing Morningstar’s holistic view of the stock. Sections include analyst commentary, the Morningstar Rating, and historical data.

Michael Hodel, CFA, 08 August 2014

Investment ThesisWe aren't fond of AT&T's decision to acquire DirecTV, butthe satellite television business will constitute a smallportion of AT&T's overall business and AT&T faces littledownside if the deal fails to close. Wireless remainsAT&T's most important asset.

AT&T's wireless unit, its largest segment at about half ofsales, is its most attractive business. AT&T and VerizonWireless have unmatched scale and resources to makethe investments needed to continue meeting customerneeds while generating strong margins and cash flow.AT&T has done a good job of capitalizing on its wirelessposition, driving improvements in customer service andcutting costs. AT&T now boasts a postpaid customer basethat is nearly as loyal as Verizon Wireless'. Phonesubsidies have hit margins, but the rapid shift to the Nextfinancing model promises to better match phone costsand revenue.

AT&T is currently investing heavily in its wireless network,which we expect will press its scale advantages versussmaller rivals over the next couple years. The wirelessindustry has grown increasingly competitive recently, withT-Mobile attacking with new pricing options. We don'tbelieve T-Mobile, or Sprint, can compete effectively onprice over the long term because of the cost disadvantagesthey face in providing quality service. AT&T's recentpricing actions have certainly been a reaction to thecompetitive environment. However, we believe the firmhas made intelligent pricing changes, encouragingheavier data usage, which showcases its networkstrength.

In the fixed-line business, we believe the firm enjoys astrong position in the business services market thanks tothe reach of its networks. At the high end of this market,very few competitors can meet customer needs as well.We believe the cable will be confined to the lower end ofthe market as a result. AT&T's residential fixed-linebusiness isn't attractive. We are skeptical of this unit'sability to retain consumer customers in the face of stiffcompetition. Even in areas where AT&T has upgraded itsnetwork to offer U-Verse services, the cable companies'networks are still typically more capable.

Despite increasing competition, AT&T still has a strong position in thewireless business.

Bulls Say

OAT&T has direct relationships with millions ofresidential and business customers. The firm'snetwork upgrade plans should enable it to offerthese customers more and better services, drivingrevenue growth.

OAT&T and Verizon Wireless stand head andshoulders above the rest of the U.S. wirelessindustry. The wireless business should generatestrong profits and differentiate the firm from thecable companies.

OThe DirecTV acquisition will make AT&T a giantin the television industry, providing it with the cloutneeded to shape the future direction of thisbusiness.

Bears Say

OA large portion of revenue and cash flow stillcomes from fixed-line local and long-distancephone services, but these business remain underattack from competitors and technologicalsubstitution.

OAT&T's heavy reliance on the iPhone is an issue.About half of its retail customers use the device.Weaning customers off of large iPhone subsidiescould prove difficult in the current competitiveenvironment.

OAT&T's local network upgrade may leave thefirm with too little capacity to offer the data speedscustomers increasingly demand. The DirecTV dealprovides yet another outmoded network.


Economic Moat Narrow NarrowValuation QQQ Fairly ValuedUncertainty Medium LowFinancial Health A- Moderate


Price/Intrinsic Value 1.00 0.91 1.06 1.03Price/Earnings 10.2 21.1 17.5 20.8Forward P/E 12.8 — 15.8 15.4Price/Cash Flow 5.4 5.1 6.6 12.5Price/Free Cash Flow 16.6 11.5 16.2 21.2Dividend Yield % 5.28 5.52 3.45 1.99

Michael Hodel, CFA, 24 July 2014

Analyst NoteAT&T's second-quarter results were messy, resulting fromthe aggressive shift away from traditional wireless devicesubsidies. The benefits of this transition were clear, asthe firm posted strong customer growth, especiallyrelative to Verizon, on record-low customer defections. Onthe other hand, wireless revenue was hit harder than wehad expected. Nearly a third of AT&T's smartphonecustomer base has shifted to cheaper no-subsidy rateplans without enrolling in the Next handset financing plan.We continue to view the move away from subsidized rateplans as an overall positive for AT&T. However, the fullfinancial benefit of this shift will take time to materialize,in the form of lower phone subsidy costs or, for thosecustomers who ultimately enroll, higher Next revenue.Changing customer behavior could create bumps,especially around cash flow, during the remainder of 2014as phone upgrade activity ramps up, but we believe AT&Tremains well positioned. Our narrow economic moat ratingand fair value estimate are unchanged.

Reported wireless revenue grew 3.7% year over year,down from 7.0% during the prior quarter. Revenue againbenefited from up-front recognition of Next installmentrevenue, as AT&T sold 3.1 million smartphones under theprogram (versus 2.9 million during the first quarter). Butthe rapid movement to no-subsidy plans, and a fullquarter's impact from this shift, caused average monthlyservice revenue per postpaid customer to drop more than$5 year over year and $4 sequentially to about $62. Goingforward, management expects to make up much of thislost service revenue via equipment installment revenue.The good news, in our view, is that if this replacementrevenue doesn't materialize, the corresponding benefit islower device expenses. Phone upgrade activity has beenmuted thus far in 2014, and the wireless EBITDA marginheld roughly steady year over year at 42% as a result.

Economic Moat Michael Hodel 08 August 2014

AT&T's competitive advantages primarily stem from itsposition in the wireless industry, in our view. VerizonWireless and AT&T dominate the industry, with about 60%of the market between their retail and wholesale


Source: Morningstar



iUSA

T

Morningstar Equity Analyst Report | Report as of 22 Aug 2014 | Page 1 of 11

AT&T Inc T (XNYS)Morningstar Rating Last Price Fair Value Estimate Price/Fair Value Dividend Yield % Market Cap (Bil) Industry Stewardship

22 Aug 2014 22 Aug 2014 22 Aug 2014 22 Aug 2014QQQ 34.50 USD 34.00 USD 1.01 5.28 178.92 Telecom Services Standard


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Sector ReportThese reports provide a bottom-up perspective on the most important trends and factors influencing equity investments and valuations for each of the 11 Morningstar sectors globally. Each quarterly report addresses competitive dynamics, trends, and our outlook for specific industries.

© 2014 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. The information contained herein is not represented orwarranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. To order reprints, call +1312-696-6100. To license the research, call +1 312-696-6869.

Sector Update

and the court of public opinion, there is a risk that the Federal Communications Commission or the Justice Department puts a hold on consolidation.

Consolidation is also occurring in Europe, cross-border. Vodafone VOD is in the process of acquiring the largest cable operator in Spain, while the largest cable operator in France is looking to acquire the country’s second-largest phone company. Meanwhile, all eyes are on the proposed merger of Telefonica Deutschland and KPN’s KPN German subsidiary E-Plus. If regulators approve this deal without too many restrictions, we think additional mergers could occur. Despite the M&A activity, which has particularly pushed up the prices of pay-television operators, there are still pockets of value across the global telecom space. Most come with baggage, either from lagging sales growth or higher legacy costs, so we encourage investors to be highly selective.

In aggregate, the technology sector is slightly overval-ued, and global telecom is fairly valued. A few areas present long-term value, notably in international telecom.

Mergers, acquisitions, and yield-seeking continue to push U.S. telecom stocks above fair value, in our view, but opportunities are still plentiful in Europe and Asia.

We have considered the technology sector to be either fairly valued or slightly overvalued for the better part of the past 18 months, whereas the communi-cation-services sector has, until only recently, been considered undervalued. However, within each subsector, there are pockets of value for patient inves-tors. In particular, we believe that the international telecom and domestic cell tower industries offer more appealing valuations.

Taking a step back, with the tech and communications sectors trading at or above fair value, we would prefer a wider margin of safety and are quick to gravitate toward firms with established economic moats, which might be in a better relative position to withstand near-term revenue and operating margin volatility.

The U.S. telecom industry is at a unique point in history, with consolidation, regulatory policy, and technology converging in a manner that could fuel fireworks over the summer. We believe that some proposed acquisitions have had a ripple effect and are forcing regulators to consider the implications of significantly greater media consolidation. At the same time, the debate surrounding the “open Internet” or “Net neutrality” have taken on greater impor-tance in the public sphere with consolidation on the horizon. As these issues are debated in Congress

Total Revenue (Bil) Market Cap (Bil) Number of Companies Total Employees Sector Price/Fair Value Universe Price/Fair Value1,531 USD 2,126 USD 61 3,528,452 1.03 1.05

Morningstar Equity Research

i Communication Services Sector Report

Peter Wahlstrom, CFADirector(312) [email protected]

Sector Update as of 25 June 2014.Pricing data through 30 June 2014. Ratings updated as of 25 June 2014.

Currency amounts expressed with “$” are in U.S. dollars (USD) unless otherwise denoted.

Industry Price/Fair Value is the median value of the companies covered by the Morningstar Equity Analysts.

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Morning NotesMorning Notes provide daily insights from Morningstar stock analysts addressing late-breaking company specific news, such as surprising quarterly earnings or a major announcement and the implications for investors.


Pick ListsMorningstar maintains four pick lists based on select companies that have an Economic Moat, our term for sustainable competitive advantage.

Key FeaturesThe Large Cap U.S. Core Picks List presents our best picks for new core equity investments in large-cap stocks within each Morningstar sector. We limit the list to stocks of U.S. companies that are part of the S&P 500 Index.

The Mid Cap Picks List surfaces our best picks for new equity investments in mid- and small-cap stocks within each sector. We look for companies with economic moats paying special attention to companies with improving moats. We emphasize U.S. stocks, but also include globally domiciled companies with shares trading on U.S exchanges.

The Morningstar Canada Core Pick List features our most attractively valued names among larger Canadian companies with economic moats. The Core Consider Buy list only includes Canadian companies with: a market capitalization of greater than CAD $5 billion; a Narrow or Wide Economic Moat Rating; and a fair value uncertainty that is not high or extreme.

The Morningstar Canada Income Pick List features our top dividend paying Canadian firms that we feel are stable and undervalued. The Income Consider Buy list only includes Canadian stocks with a Narrow or Wide Morningstar® Economic Moat™ Rating; a fair value uncertainty that is not very high or extreme; and a market price less than our fair value estimate (i.e. no overvalued companies).

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Analyst Insight Articles Analyst Insight Articles give timely investing insights and highlight stocks and themes favored by our analysts and strategists.

? 5 Key Questions for JPMorgan Investors Outperformance is increasingly unlikely.

Analyst Perspective

The consensus view is that JPMorgan Chase will continue to appreciate over the next 12 months as

rising rates boost earnings while expenses fall off. However, these factors are largely out of

management's control—movements in short-term rates depend on an increasingly cautious Federal

Reserve, and the costs of litigation and compliance are continuing to be forced upon the bank from

outside. Also, many of JPMorgan's top managers have departed and the firm is no longer successfully

avoiding the blunders of its peers; incidents like the London Whale trades, the Comprehensive Capital

Analysis and Review stumble, massive legal settlements, and seemingly endless allegations of

wrongdoing recently led us to reduce our Stewardship Rating to Standard from Exemplary.

JPM bulls still see the company as a bargain at just above book value, but we see limited upside in the

shares. The firm has never achieved—and management is not targeting—profitability on par with Wells

Fargo WFC, U.S. Bancorp USB, or PNC Financial PNC. At current prices, we believe the risks facing the

bank—regulation, competition, and even disruption—offset the potential for earnings and multiple

expansion. Our fair value estimate remains $58 per share.

Key Takeaways

× Upside from here depends on rising interest rates…but a dovish Fed and the Japanese experience

lead us to believe that short-term interest rates will remain low for an extended period.

× …and declining expenses. Yet head count is at already the lowest level in years, the legal and

regulatory environment remains challenging, technology investments are rising, and compensation is

likely to rise along with revenue.

× Expansion of the price/tangible book value multiple is not justified by JPMorgan's middling

profitability record and its modest dividend growth prospects.

× Succession is still a concern as turnover in the top ranks has depleted the pool of candidates to

choose from.

× Management appears less bullish. Share repurchases have tailed off as the stock price has risen, and

executives have sold approximately $50 million in shares over the past 12 months.

Companies Mentioned

Name/Ticker Economic Moat

Moat Trend Currency

Fair Value Estimate

Current Price

Uncertainty Rating

Morningstar Rating

Credit Rating

Market Cap (Bil)

JPMorgan Chase JPM Narrow Stable USD 58.00 58.00 High QQQ A- 212.00

Morningstar Equity Research 22 July 2014

Jim Sinegal Senior Analyst – Banking and Payments +1 312-696-6105 [email protected]


Analyst Videos Analyst Videos deliver valuable insights on companies,industries, and market trends. Morningstar produces several videos per week that help investors better understand key investment topics.


Weekly Research Highlights Weekly Research Highlights surface our analysts’ current favorite stocks, address big-picture trends, and highlight significant ratings changes.


Quarterly Market Outlook Quarterly Market Outlook showcases our fundamental, forward-looking view of the equities market, sector by sector. We aggregate the valuations of the stocks we cover to address whether each sector is under-or over-valued.

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Market Outlook Q2 2014

March 26, 2014

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Our Outlook for the Stock MarketAs investors flock to risky stocks, we think it’s a good time to play defense.

By Lauren Adams, CFA | Director of Cross-Sector Equity Research

Markets have largely recovered from January’s correction, and the average valuation of our coverage universe continues to tick up, standing at 104% of fair value going into the second quarter (all market and geographic averages are on market-capitalization-weighted basis).

In a market leaning toward the overvalued side, investors must dig deeper to unearth buying opportunities. However, macro instability has created some buying opportunities, especially in a number of energy and high-quality consumer staples stocks.

On a global scale, firms that our analysts cover in Asia Pacific now look to be the most undervalued, reversing the region’s most overvalued position at this time last year. Conversely, North America and Europe look to be the most overvalued.

Macro Instability Made for a Rocky First QuarterMarkets offered a bumpy ride during first quarter and, with the S&P 500 up less than 1% year to date, investors aren’t much better off than when we started 2014. Unrest has resurfaced in Turkey, and the crisis in Ukraine has brought uneasy relations between Russia and the Western allies to a head. Although both these markets are a drop in the global macroeconomic bucket, the turmoil has sparked wider concern regarding slowing growth throughout the emerging markets, which have proven to be a key source of growth for large multinationals.

In addition to macro instability, markets also face additional uncertainties during second quar-ter. The U.S. Federal Reserve has been scaling back its asset purchase program, stemming the flow of free money that had previously lubricated markets. And we have yet to see the full fallout of how the severe weather’s impact on the consumer will impact corporate earnings.

It’s a Good Time to Play DefenseDespite these unknowns, markets have resumed their bull market trajectory, and we have seen more investors flock to riskier stocks and increase their willingness to pay up for growth. However, in general, we think investors should pull back on risk when enthusiasm is running high and the market’s valuation is relatively rich. Applying Warren Buffett’s “be fearful when others are greedy and greedy when others are fearful” mantra, we think the pendulum is swinging closer to the side of greed at the moment. In contrast, we think investors should load up on risk when fear is pervasive and valuations are depressed.

In fact, we often relish times of uncertainty as it allows us to buy wonderful businesses on the cheap. In late 2008 and early 2009, we had hundreds of 5-star recommendations. Now, although the market as a whole is leaning more and more toward the overvalued side, our team

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©Morningstar 2014. All Rights Reserved. The information, data, analyses and opinions presented herein do not constitute

investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security;

and are not warranted to be correct, complete or accurate. The opinions expressed are as of the date written and are subject

to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions,

damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information

contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in

any manner, without the prior written consent of Morningstar. To order reprints, call +1 312 696-6100. To license the research,

call +1 312 696-6869.

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