Morningstar Equity Research: Methodology Overview and Ideas from Top Analysts in the

WSJ’’s Best on the Street Survey

Heather Brilliant, CFA

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© 2013 Morningstar, Inc. All rights reserved.

Heather Brilliant, CFAErin Davis – International BanksBrett Horn – Business ServicesErin Lash – Consumer Products

Unique and Consistent ‘Intrinsic Value’ Approach

× Focus on business value, not what others will pay

× We do primary research, formulating our own opinions by reading financial filings & trade journals, visiting companies, talking to competitors & customers, and attending industry conferences.

× We have a long-term perspective backed by rigorous DCF models

× We believe that competitive advantages–“economic moats”–add intrinsic value, and we rigorously assess the competitive position

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value, and we rigorously assess the competitive position

× We believe that the ability of a business to generate ROIC above cost of capital is the primary test of shareholder value creation

× Intrinsic value principles work for both ‘value’ and ‘growth’ stocks

× Consistent approach among analysts vs. varied fiefdoms of sell-side

Differentiated Approach to Ratings & Ratings Changes

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Economic Moats Concept

× Basic premise: Capitalism works

× High profits attract competition

× Competition reduces profitability

× But some firms stay very profitable for a long time – by creating economic moatsto protect profits

× Economic moats are structural business attributes that help companies generate high returns on capital for an extended period

× Sustainable returns on capital are much more important than high returns on capital

× Crocs CROX or Nokia NOK vs. Kinder Morgan KMP or Union Pacific UNP

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10-Year Return Shows Stark Difference Between NOK and KMP

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Sources of Economic Moats

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► Intangibles that block competition and/or allow companies to charge more

► Brands:

► Sony SNE vs. Tiffany TIF

► Patents:

Intangible Assets | A Source of Moats

► Patents:

► Pharmaceuticals

► Licenses & Government Approvals

► Corporate Culture:

► Berkshire Hathaway BRK.B

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► Time = Money, and vice versa

► The cost of switching exceeds the expected value of the benefit

► Oracle ORCL

► Autodesk ADSK

Switching Costs | A Source of Moats

► Autodesk ADSK

► Praxair PX

► Razor and blade models entrench repeat consumables customers

► Waters Corp WAT

► ADT Corp ADT

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► The Network Effect is present when the value of a service grows as more people use a network.

► With each additional node, the number of potential connections in a network grows exponentially

► MasterCard MA, Visa V

The Network Effect | A Source of Moats

► MasterCard MA, Visa V

► eBay EBAY

► Apple iOS AAPL (Apps)

► Google Android GOOG (Apps)

► CME Group CME (Financial Exchange)

► Facebook FB

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► Allows firms to sell at the same price as competition and gather excess profit and/or have the option to undercut competition.

► Economies of Scale:

► United Parcel Service UPS (Distribution)

Cost Advantage| A Source of Moats

► Sysco SYY (Distribution)

► Intel INTC (Manufacturing)

► Low-Cost Resource Base:

► Ultra Petroleum UPL

► Compass Minerals CMP

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► When a company serves a market limited in size, new competitors may not have an incentive to enter. New entrants would cause returns for all players to fall well below cost of capital.

► Natural Geographic Monopolies:

► Airports

Efficient Scale | A Source of Moats

► Pipelines

► Niche markets:

► Defense Companies

► Graco GGG, Alexion ALXN, etc.

► Rational Oligopolies

► Canadian Banks

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Measuring a Moat: ROIC is Key

× A company that is likely to compound cash flow internally for many years is worth more today than a company which isn’t.

× Look for ROIC > WACC for the next decade (Narrow) to two decades (Wide)

× Duration of excess returns is far more important than absolute magnitude

RO

IC

Time Horizon

Wide EconomicMoat

RO

IC

Time Horizon

No EconomicMoat

RO

IC

Time Horizon

Narrow EconomicMoat

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Why Moats Matter: Moats tell us about risk

9%Wide

ROA

1.48

1.31

1.14

None

Narrow

Wide

Leverage

3.20M

3.06M

5.37M

None

Narrow

Wide

Liquidity

19%Wide

Volatility

1.29

1.09

0.89

None

Narrow

Wide

CAPM Beta

Increased Likelihood of Dividend Cut

2%

6%

9%

None

Narrow

Wide

$6B

$15B

$51B

None

Narrow

Wide

Market Cap

32%

25%

19%

None

Narrow

Wide

32%

25%

23%

None

Narrow

Wide

|Drawdown|

1.0x

1.8x

2.5x

Wide

Narrow

None

1.0x

17.0x

53.0x

Wide

Narrow

None

Increased Likelihood of Bankruptcy

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× After another year of excellent performance, our Wide Moat Focus Index has now outgained the S&P 500 by more than 600 basis points on an annualized basis since 2002 and outperformed in seven of the last ten years.

× Our Wide-Moat, 5-star stocks have generated an annualized return of over 19.72% since 2002.

Morningstar Equity Research Performance

× Our ratings have generated exceptional performance over the long term. The Morningstar Conviction Long Portfolio (composed of our 20 most under-valued and highest conviction stocks) has returned over 17% annually since inception.

× Thirteen Morningstar analysts were ranked as “Master Stock Pickers” by the Wall Street Journal, the greatest number of ranked analysts among winning firms this year.

Morningstar Equity Research Performance Record

Trailing 1-Year*

Trailing 3-Year*

Trailing 5-Year*

Trailing 10-Year*

Morningstar Wide Moat Focus Index 16.76 12.85 12.34 13.67

Morningstar Tortoise 23.76 13.68 7.66 9.17

Morningstar Hare 17.03 12.02 7.82 11.27

Morningstar Dividend Builder 20.28 15.25 6.27 —

Morningstar Dividend Harvest 27.37 21.40 13.69 —Morningstar Dividend Harvest 27.37 21.40 13.69 —

Buy at 5-star / Sell at 3-star 14.44 11.42 12.11 14.91

S&P 500 Index (cap-weighted) 16.90 12.80 5.21 7.88

Morningstar Large Cap Blend Mutual Fund Cat 15.65 10.86 4.09 7.15

Time-weighted returns through 04/30/2013 * Annualized percentage returns Source: Morningstar

× The Tortoise and Hare Portfolios have generated combined annualized returns of 8.38% vs. 4.37% for the S&P 500, since 2001.

Morningstar Rating

Trailing1-Year %

Trailing3-Year*

Trailing5-Year*

Trailing 10-Year*

Since Inception*(26 Aug 2002)

QQQQQ 31.87 20.27 16.54 20.71 19.72

QQQ 17.55 14.33 6.91 8.46 6.73

Performance Record of Wide Moat Stocks

Time-weighted mean returns through 04/30/2013 * Annualized percentage returns Source: Morningstar

QQQ 17.55 14.33 6.91 8.46 6.73

Q -1.73 7.33 -7.35 -2.13 -4.80

S&P 500 Index (cap-

weighted)

16.90 12.80 5.21 7.88 7.23

Fiserv- A Wide Moat, Stability and Good Management

× We think a wide moat surrounds Fiserv’s primary product, due to high switching costs. Recent replacement rates imply that the average bank maintains its core processing system for over 30 years. Fiserv leverages this essentially captive customer base to cross-sell ancillary products.

× With 80-85% of revenue recurring, Fiserv benefits from a stable revenue base.

% of Banks and Credit Unions Changing Core System

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0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

2006 2007 2008 2009 2010 2011

% of Banks and Credit Unions Changing Core System

Source: Automation in Banking, FDIC, NCUA

Fiserv- A Wide Moat, Stability and Good Management

× We think stewardship has been exemplary. CEO Jeff Yabuki's cost control results have been impressive, especially considering the headwinds during the crisis.

× While slightly overvalued, we think Fiserv is a good stock to keep on the radar in case of a pullback, and potentially a very attractive defensive long-term holding.

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24.0%

25.0%

26.0%

27.0%

28.0%

29.0%

30.0%

2007 2008 2009 2010 2011 2012

Fiserv Adjusted Operating Margins

Note: Source: Company filings (margins exclude purchase amortization expense and one-time items).

Sysco Poised to Serve Up Cost Savings and Share Gains

× Sysco is the undisputed industry leader and has garnered a wide moat with an expansive distribution network and 17.5% share of the highly fragmented food-service distribution industry

× Sysco has actively participated in the industry's consolidation, completing more than 150 deals, and management's hunger for deals has yet to subside, with acquisitions expected to contribute around 1% of sales growth each year.

× Challenges stemming from sluggish restaurant traffic and food cost inflation persist, but we still think Sysco should be well positioned when there is a more but we still think Sysco should be well positioned when there is a more consistent positive cadence to restaurant sales.

× In a market where little looks overly appetizing, Sysco's shares strike us as mildly tasty, as the market appears to be ignoring the breadth and depth of Sysco's distribution network and product set.

× Income investors should give the shares a look. The firm is committed to its dividend, paying one each year since 1969 and targeting a payout ratio of 40%-50%.

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UBS – New Strategy Builds on UBS’s Moat

× UBS’s new strategy focuses its moaty private bank.

- The world’s largest private bank with CHF 1.7 tn of invested assets.

- Private banking customers tend to be sticky and not very price sensitive

- ROE typically > 40%.

× Scaling back on risky investment banking× Scaling back on risky investment banking

- Closing sub-scale fixed-income trading desks

- Exiting businesses with excessive tail risk

- Targeting a 30% reduction in funded balance sheet

× Best in class capital strength

- Fully applied Basel III equity tier 1 capital ratio = 10.1%

- Common tangible equity / tangible assets = 4.9%

Comprehensive Coverage

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