Plus, how earnings season could play out.
Hello, and welcome to The Morning Filter. Every Monday, Susan Dziubinski sits down with Morningstar Chief U.S. markets strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.
Key Takeaways:
Market Recap & Valuations Today
What to Expect During Earnings Season
New Research: Cybersecurity Stocks, META & GOOGL
Stock Picks of the Week
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Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar research services chief US market strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead.
Good morning, Dave. We had one heck of a week last week in the markets. Recap the market activity for our audience.
David Sekera: Good morning, Susan. I think that’s going to be the understatement of the day to start off with. Last week, we started off with stocks on Monday and Tuesday and even first half of Wednesday continuing their selloff. And then on Wednesday afternoon, we saw stocks just skyrocket higher after President Trump announced a 90-day pause on tariffs. However, you do have to note that that pause actually excludes China, which of course is one of our largest trading partners. But either way, the S&P 500 rose well over 9%, I think was even getting close to over 10% up for the day.
But the rally was a combination of really two things. So first, short-covering. Any of the hedge funds that were short going into the market at that point in time just had to cover their shorts because they were just getting their eyes ripped out on those shorts. And then of course there’s also just investors taking the worst-case scenario off the table.
Now we gave back probably about half of those gains on Thursday and then went out on a positive note on Friday. So, overall, stocks were up about 5.5% for the week. At this point, I think, the Morningstar US Market Index is down about 9% year to date. And futures are looking good this morning, we’re up well over 1% about right now.
However, having said all that, I do think it’s too early to give the all-clear signal. The tariffs on China are so high. Morningstar’s US chief economist thinks it’s effectively an economic embargo on China. And I have to note: Trade negotiations haven’t even begun yet. I suspect that once negotiations begin, that’ll probably drive some more market volatility. I think there’ll just be a lot of headline risk as each side is going to use the media in order to leak stories, try and help position themselves, just to be able to extract as much concessions as they can from each other’s side. So at the end of the day, I don’t think this is all over just yet.
Dziubinski: Last Monday, Dave, you told viewers that you thought it was time to edge into an overweight position in equities. So it’s a week later. What do you think today?
Sekera: So a lot of movement going on. At this point US stocks are now trading at about a 12% discount to a composite of all of our fair valuations. So the market’s still pretty undervalued, but not nearly as undervalued as it was Monday morning when we made that call. So if you bought stocks Monday or Tuesday or even Wednesday morning, I think the rally Wednesday afternoon to some degree was a bit of a gift. I think a lot of people probably used that to lock in profits and then you were able to reload that position on Thursday when stocks were down over 4%. Now having said all that, if you didn’t sell on Wednesday and you’re still going into that overweight position, I think valuations remain low enough that, over a longer time period, your investment will probably work out just fine over time.
So futures up over 1% this morning, and that’s really due to some guidance over the weekend from the US Customs Department. Electronics, things like smartphones, computers, and other components will be exempt from reciprocal tariffs. So a lot of people are asking, is this it? It is the bottom in? Certainly possible, but in my opinion, I don’t think so. Over the weekend, US Commerce Secretary Lutnick was on record saying the tariffs on those exact same things, smartphones, computers, semis, and other electronics, may be subject to separate tariffs in the next month or so. So I think investors still need to be prepared that we could see downward movement if that happens, if tariff negotiations go sideways, or if they just take a longer time to play out than expected.
And I also think this earnings season, there’s a pretty high probability that guidance may be disappointing to the markets. I think people’ll be listening for what management has to say on earnings conference calls.
So if we get a selloff, I think you do need to have that target set where you want a dollar-cost average in more. And if we continue this rally, have that target set for where you want to be able to take that profit and get back toward that market-weight position.
Having said all that, any good news on tariff negotiations or if management is still able to instill confidence among investors, yeah, still potentially a lot of movement up from here. So, again, have that target set to your upside and to your downside and keep to those targets when the market moves.
Dziubinski: Now, as Dave just pointed out, the tariff story is still evolving, and we don’t know where the story’s going to end. So given that, Dave and I wanted to give The Morning Filter’s audience a chance to hear from Morningstar’s director of equity research in North America, Damien Conover, about how Morningstar’s analysts our incorporating today’s uncertainty into their valuations and research. Damien and I chatted last Friday morning. Take a listen.
Damien, let’s begin with a brief explainer about how Morningstar comes up with a fair value estimate for a particular stock. What inputs are Morningstar analysts using, and over what time frame are analysts making their forecasts?
Damien Conover: Yeah, thanks Susan. It’s a really important question. It’s sort of the core of what we’re doing when we’re looking at stock valuation analysis. And the key tool we use is a discounted cash flow model. And basically what it is is we look at projected cash flows for each individual company over three different stages of time. There’s a stage one, which is going to be our explicit forecast period, that tends to be five to 10 years; a stage two, which is a fade period; and then stage three, which is a perpetuity.
Now specifically to your question on inputs, stage one is really going to be the key dynamics of what we think the company is going to do from a growth perspective, so like sales growth, from a margin perspective, are margins going up or down, capital expenditures—really forecasting all the different financial statements. And that will be in the explicit forecast period.
And then the stage two, the fade period, will have some of their assumptions, but they’re a little bit higher-level. There’ll be return on new invested capital, growth rates, and that fades us to the perpetuity.
Then finally, we discount it all back at the weighted average cost of capital, which is unique for each firm. Then that gets us to the valuation.
Now, one last point that I’d make that and I think is really important, and I think unique to Morningstar, is we also have the input of the economic moat. And the economic moat helps us define the exact periods of time of excess returns and also helps inform some of those inputs in that first stage when we think about margins. Like if it’s a wide economic moat, that’s probably going to be a firm that’s going to have sustainably strong margins. And that also helps us think about where we think those cash flows are going to be. And then again, we discount them back, we get the fair value, and that will be the fair value we go out with for each one of the firms we cover.
Dziubinski: Now, of course, investing is always uncertain. But we seem to be in a particularly uncertain period where many outcomes are possible when it comes to forecasting what impact tariffs could have on a company. How are Morningstar’s analysts determining what’s probable when it comes to the impact of tariffs on their companies today?
Conover: Yeah, great point, Susan. So there’s really a whole range of different outcomes; you think about a distribution of outcomes. And when we look for a fair value, we’re really looking for the 50th percentile, the most likely outcome for a particular firm. And what analysts really strive to do is decipher between noise and signal with all the incoming information. And in these current days, there’s been a lot of noise, there’s been a lot of signal as well. And what analysts do is they work toward thinking about what they believe is the most probable signal that will then inform the changes, potentially, to a discounted cash flow model. Now, a couple of things that I think is particularly important when thinking about tariffs is we really want to look at the long-term impact. So we’ve gotten some announcements recently and those announcements initially came out, then pulled back, and negotiations are underway.
So analysts are working toward thinking what they believe is the most likely outcome for tariffs, and then importantly, thinking about what that means for their companies. So companies can adapt to these tariffs. Firms with wide economic moats tend to have stronger pricing power, and they might be able to adapt and pass along different sort of tariff impacts if those tariffs do impact that individual company. And so really the key here is what’s the long-term impact, what’s the signal, what’s not the noise? And then let’s get to the 50th percentile, the most likely outcome, and that’s going to be where we land on our fair values.
Dziubinski: So then, Damien, is there a role that Morningstar’s economic forecasts play in determining a specific company’s fair value?
Conover: Yeah, I think that’s important as well. So when we think about tariffs, there’s two ways to unpack them. First, you got the first-order impact. That’s going to be any firm that’s going to be impacted from direct impact from tariffs, either importing or if there’s retaliatory exporting. But there’s also a secondary impact here potentially causing economic harm to the overall system. And we have an economic research department that our analysts lean into. And that department really looks at what’s going on somewhat in the short term, but really more importantly contextualizes it for the long-term output.
And our firms that have more economically sensitive variables, those are going to be the companies that we will really be looking to our economic research department, too, to help us sort of unpack the challenges. And I think one example here is Disney DIS. We recently lowered the fair value of Disney. Now that was heavily driven by some of the increasing macroeconomic challenges that our economic department think there will be. And so our analysts incorporated that, we brought down our fair value a bit. Keep in mind: Disney’s pretty diversified, but they do have a lot of profits coming from experiences, theme perks, like that. And when the macroeconomic headwinds increase, our analysts are going to incorporate that.
Dziubinski: Now, Morningstar also assigns Uncertainty Ratings to the stocks its analysts cover. In a situation like this where there seems to be an increase in uncertainty around this tariff question, why not increase the Uncertainty Ratings on all stocks to High or Very High across the board right now?
Conover: Yeah, I think that’s a good question, and that’s something all our analysts are wrestling with. I mean, just to unpack Uncertainty briefly real quick before we get into some granularity with your question. When we think about uncertainties, these are the ratings that really guide our investment community to know how big of a cone of uncertainty of potential outcomes there could be. I talked earlier about the 50th percentiles, where we’re looking for our fair value, but if the distribution of those outcome is really wide, that’s going to be a High Uncertainty. I think it’s important to note those Uncertainty Ratings do impact our star ratings. So we’ve talked a lot about fair values, but also keep in mind we do assign star ratings. And the way the Uncertainty Rating works with the fair value is, the higher the uncertainty, the bigger the discrepancy we’re going to need between the fair value and the current stock price before it will be a 5-star or 1-star.
For example, Johnson & Johnson JNJ, this is a Low Uncertainty firm. We don’t need to see a high discrepancy between the current stock price and where the stocks is before we move into a 4-, 5- or a 2-, 1-star call.
So within that backdrop, and to your question specifically, why not just go ahead and bump up all the uncertainties? And to be certain, we have increased some of our uncertainties. However, we also don’t want the analyst community to hide behind the Uncertainty Ratings because if we move all our uncertainties up to Very High, most of our star ratings are going to move closer to 3 stars, which is fairly valued, and we’re not going to be able to give investors the insights that we think they deserve.
Now all that being said, we’ve certainly seen an increase in uncertainty since early April, and we have changed a lot of our Uncertainty Ratings. One company in particular is UPS UPS. This is a firm, obviously, that does a lot of global logistics, deliveries. And as we’ve seen this news in tariffs, also potential secondary impacts in the macroeconomic environment, we have increased the Uncertainty to High. So we are trying to employ that uncertainty metric when it is appropriate. But again, we’re probably not going to do a vast upgrade all to Very High Uncertainty because we do want our star ratings to provide some good value to investors.
Dziubinski: Damien, can you give us a sense of what percentage or how many of Morningstar’s fair value estimates could be revised down from their current levels? And building on that, is there a time frame during which the analysts are reviewing their companies?
Conover: On time frame, we are evaluating our fair values constantly. We’re constantly bringing in the information, looking at it between noise and signal. If it’s signal, we’re looking into our fair values through the discounted cash flow model. And if it’s a material, we’re making those changes immediately. Now, as far as magnitude, that’s really going to be done on a company-by-company basis. There are industries that are a little more exposed to tariffs. There are industries that are a little more exposed to macroeconomic environment. In talking with our US sector directors, we’ve identified close to 20% of our industry’s a little bit more sensitive to tariffs. And we’ve also identified close to 80% of our industry is more sensitive to macroeconomic environment.
Now that being said, there are spaces where there really is going to be likely very limited impact. So consumer defensive, healthcare, these are areas where both they have less tariff exposure and they have less macroeconomic pressure. These are goods and services you need all the time. So there is a range of different outcomes, but it is really on a company-by-company basis.
Dziubinski: Can you give us a sense of the magnitude of a typical percentage fair value change we might see as a result of tariffs and a potential economic slowdown?
Conover: Yeah. I think when we think about unpacking it, it’s going to come down to the unique attributes of each company. Some companies with wide economic moats are able to pass on some of these challenges a little bit better than others. And like I said before, there’s different levels of sensitivity to the market. However, we do have some examples of a lot of changes that we’ve made. One area that is very clear for us is the economic impact of tariffs to the shale companies. We’ve decreased our shale production companies by up to 4%. So those fair values have all come down. We have other examples where the fair values have come down more if they’re a little bit more exposed. So it’s I think a full range, but again, it’s that company-by-company basis, looking at the long-term impact. Keep in mind, some of these changes are more on the short-term basis. And when you think about it from a long-term discounted cash flow model, some of those changes just don’t have as big of an impact as what the current events might suggest they could.
Dziubinski: So then to wrap up, Damian, what advice would you give investors who are using Morningstar’s ratings and our fair value estimates to make investment decisions today?
Conover: Yeah. I think right now we’re in very stormy times, but one of the things I really appreciate about our research is the methodology and the philosophy. And that’s really guided by a long-term outlook substantiated by economic moats. And for investors, I think they should really utilize the ratings and think about the commentary as context around those ratings to help them think about how best to navigate these stormy times.
Dziubinski: Damian, thanks so much for your time today and your thoughtful comments.
Conover: Thanks, Susan.
Dziubinski: All right, Dave, let’s pivot over to the week ahead. Now, it’s a short week, with the markets closed on Good Friday. So what’s on your radar this week on the economic front? And really how important are these backward-looking reports to the market in the uncertain tariff era anyway?
Sekera: When I’m looking at the economic metrics this week, I don’t see anything that I think would be market-moving, but one that I do want to address is going to be the Atlanta Fed GDPNow. Now that it’s gone negative, I’m hearing a lot more people starting to talk about it than in the past. But the funny thing is, in the past, you and I have talked about it a number of times, we look at as being more of a real-time indicator of the economic run rate. And back then, it didn’t seem like anyone really cared about it. But now that it’s negative, everyone’s talking about it, but yet now, actually, I kind of don’t care. So the reason why is reported GDP for the first quarter, we think it’s going to be heavily distorted by the amount of purchasing and the amount of imports that were being made before the tariffs went into effect. Essentially, companies looking to front-run those tariffs. And we think that that amount of imports will end up artificially lowering the way GDP is reported for the first quarter. But yet, once that inventory is used and it’s sold, that will then artificially bolster reported GDP next quarter.
Now we also do have Federal Reserve Chair Powell scheduled this week to make remarks at the Economic Club of Chicago on Wednesday. In my mind, I expect it to be a nonevent. Chair Powell always chooses his words very carefully, and I think he’ll be especially guarded this week as far as any remarks that he makes publicly.
Dziubinski: We also have a flurry of earnings reports coming out this week. But before we get to the specifics, talk a little bit about what your expectations are heading into earnings season.
Sekera: For earnings in and of themselves, I think for most companies there’s really no reason why their first-quarter earnings shouldn’t be in line with expectations. Now, having said that, I do want to highlight in the tech sector, we could see some hiccups there. So we did have the bear market and AI stocks beginning in mid-January, and there’s a potential that could have led to some pullback in the rate of spending on AI. So that’s the one specific area that I do have some concern on.
But again, it’s all going to be about guidance, outlooks, and commentaries on the conference calls. And I think there’s a pretty high probability that could result in some pretty negative market sentiment. So when I’m thinking about the tariffs in and of themselves, management teams that do provide guidance, they may pull that guidance, they may just not want to give any guidance for the second quarter. Or if they do give guidance, it might just be such a big wide range. I mean, you’d be able to drive a truck through it. And so in that case, it’s almost kind of meaningless in and of itself.
I think the analyst community will have a lot of questions asking management, How are tariffs going to affect your business? What are you doing to mitigate it? And management teams might not have a lot yet to really say about it. So my concern there is that either they won’t comment on the tariffs at all, or if they do comment on it, they’re just not going to have enough time really to figure out how to restructure supply chains in order to limit that impact. So I think if there’s a lack of specificity here, I think that would be very disconcerting for investors.
Dziubinski: All right. Let’s talk about a few specific companies that are on your radar that report this week. And let’s start with Johnson & Johnson. Now, this is a stock you’ve referred to in the past as a core holding. How does it look heading into earnings, and what will you be listening for?
Sekera: The stock’s currently rated 4 stars, trades at a 7% discount to our fair value, has a 3.3% dividend yield. It is a company with a wide economic moat. We rate the stock with a Low Uncertainty Rating. So I’m going to be listening for any discussion on their strategy as far as resolving claims from their talcum powder liability. Recently, the judge there declined that settlement, so I think we’ll listen for exactly more guidance as far as the company, as far as how much that could be, and what the time frame is going to be. And then on the tariff front, pharma and biopharma, the industry there has largely been exempt from tariffs thus far. However, there is some talk about potential tariffs in the future. So I’d be listening for any discussion as far as how they may look to restructure their global manufacturing strategies if there are tariffs put in place there.
Dziubinski: And you also have a couple of technology companies on your radar this week, ASML ASML and Taiwan Semiconductor TSM. Why are these two that you’re watching?
Sekera: Well, first with Taiwan Semiconductor, it is a 5-star-rated stock, trades at over a 40% discount. That stock down is over 30% from its high before the DeepSeek news came out. And for those of you that aren’t familiar, Taiwan Semiconductor is the company that makes the GPUs for Nvidia for artificial intelligence. I think this will be a pretty good preview as to what’s going on in AI capex spending. So any beat or miss here can impact all of the AI stocks, which, of course as we’ve talked about, have been in a bear market since mid-January.
ASML, that’s the company that makes the advanced equipment to actually make semiconductors. It’s a 4-star-rated stock at a 24% discount. So any guidance that they give here, I think that’s a first clue for the outlook for AI hardware. Tariffs in and of themselves not applied to semiconductors, but we also want to hear some additional clarity as to whether or not the tariffs would apply to the equipment that then actually makes the semiconductors.
Dziubinski: All right. Let’s shift over to some new research from Morningstar. Now, last week we had JPMorgan JPMand Wells Fargo WFC report earnings. What did Morningstar think of the results? And did any commentary from management at either firm stand out to you?
Sekera: JPMorgan is a 2-star-rated stock, trades at a 20% premium to fair value. Wells Fargo is a 3-star-rated stock, trading really close to our fair value estimate. JP did beat on top and bottom line, however, we maintained our $195 per share fair value estimate. Wells, it missed on the top line, but it did beat on the bottom line based on cost savings. And a lot of those cost savings are already incorporated into our fair value, which is at $65 a share, which we maintained.
Now, as I talked about earlier, I didn’t see any reason why they should miss first-quarter earnings, why they shouldn’t have been in line with expectations. They shouldn’t have been impacted by any of the selloff in the AI stocks, and all the “Liberation Day” tariffs were after first quarter was announced.
I think the most important thing here, and maybe what investors want to go back and do, is read the transcript from the JPMorgan call. And I think Jamie Dimon there was quite explicit in his economic expectations. He noted that he foresees the economy facing what he considered to be considerable turbulence due to tariff-related disruptions. He expects corporate earnings to decline at least 5% as opposed to the current Street estimates, which are up 5%-10%. And JPMorgan is also now starting to incorporate weaker consumer spending going forward. So to do that, they did increase their loan-loss reserves. Now, if it were to be a recession, we’d expect credit provisions to go up even further from there. However, we wouldn’t expect it to be as bad as what we’ve seen in some of the more recent recessions.
So as far as both of these stocks go, and actually all the large banks overall, now our analysts noted, if there is a recession, which is not our base case currently, but if it did happen, fair values among the large banks could drop anywhere in that, mid—I’m having a tough time this morning—they could drop by that midteen percentage. I think JPMorgan is pricing in a 50% probability of recession, which is really close to Morningstar’s US economics team’s probability of 40%-45% of a recession.
Dziubinski: Morningstar’s cybersecurity stock analyst issued some new research last week. And in it he argued that cybersecurity stocks looked attractive. First, what’s the rationale for that?
Sekera: First of all, I have to highlight a lot of these cybersecurity stocks are actually still in the green year to date, only Palo Alto PANW is in the red, but they all did sell off with the broader selloff in the market. And we’ve talked about cybersecurity a lot of times. One of the reasons I really like this sector, this industry overall, is that, in our view, even in a recession, management teams aren’t going to cut the budgets for cybersecurity. Cyber overall is a relatively low percentage of their overall IT budget but yet has very significant negative consequences both monetarily and reputationally if a company were to suffer a hack. And lastly, tech services such as cyber aren’t subject to tariffs. So this is an area that we still like today.
Dziubinski: How do the cybersecurity stocks that Morningstar covers look today? I think they’re probably up from where our analyst note came out. So are there any attractive opportunities left?
Sekera: Palo Alto would be the one I’d highlight right now, 4-star-rated stock at a 20% discount. A company we rate with a wide economic moat, although like a lot of tech companies, it does have a High Uncertainty Rating. And I think Palo Alto is probably one of just the highest-quality cybersecurity companies today, so I think that one does look attractive here.
Dziubinski: All right. Now also last week we had Morningstar’s analyst who covers Meta Platforms META and Alphabet GOOGL issue new notes reaffirming Morningstar’s fair value estimates on these two stocks and saying that both looked attractive. Let’s start with Meta, Dave: Why is Meta a buy today?
Sekera: Meta is currently rated 4 stars, trades at a 30% discount to fair value. And I think the most recent news here, which is probably pretty attractive for the longer-term valuation of the stock, is the company released Llama 4, that’s its next-generation large language model. Now, overall, we believe GenAI models are being leveraged by and advertisers to create increasingly more-personalized content for users, which overall we expect will drive greater engagement and even more monetization over time.
Dziubinski: What about Alphabet?
Sekera: Five-star rated stock, well over a 30% discount to fair value. Now, that stock has sold off on fears of a recession. The concern there that, in a recession, you’d have a pullback in advertising, but we believe the company is competitively very well positioned even if digital-advertising spending were to slow down. And we think the market is underestimating the amount of growth that they’ll get this year. We think its cloud business will accelerate here in 2025 as capacity constraints from last year begin to ease. And even in a recessionary scenario in which digital-advertising spending slows, we’d only expect about maybe a 10% fair value decrease. So with the stock as much of a discount as it is, even in a recession, it would still look attractive to us.
Dziubinski: All right. Let’s move on to the picks portion of the program this week, which was inspired by a question from a viewer, who also happens to be named Dave. So Dave asked, “Dave has mentioned in the past that J&J and ExxonMobil XOM are long-term core holdings to consider. Does he have any other examples?” So, first, Dave, did you plant this question?
Sekera: No, but I should have. I wish I was actually smart enough to do that. Of course, I wouldn’t have used my own name if I did plant it.
Dziubinski: How do you define a core holding? What’s that mean in practical terms?
Sekera: Like anything else in finance, you’re going to have different meanings to different people. In my own opinion, core holdings, these are the ones that have what I would consider a Warren Buffett time period for holding period. His time period that he holds stocks, he wants to hold stocks as forever. I think of them as the kind of stocks that you’d be willing to put your parents into. Those companies are just the highest quality, have the widest moats, the strongest management teams, have a history of exemplary capital allocations, attractive dividend yields, solid balance sheets. Companies that we think would hold up better to the downside than the competition in a recession.
Those companies that have steady, maybe not spectacular, but very steady long-term earnings growth expectations. Again, these are the ride-or-die type of stocks. The ones that you’re willing to not only hold through any kind of market downturn, but be able to dollar-cost average into increasingly larger positions to the downside. But of course then when they start moving back up, lock in some profit, sell them to the upside. But again, you never really want to completely sell out of these even when they start moving above your fair value estimate.
Dziubinski: All right. Today you’ve brought us four core stocks that you like today at current prices. That first core stock to buy is Microsoft MSFT. Walk us through the key metrics.
Sekera: Microsoft’s a 4-star-rated stock, trades at just over 20% discount to fair value. Not much of a dividend yield, it’s under 1%, but again, at least it pays a dividend. It’s a company we rate with a Medium Uncertainty and a wide economic moat. The wide economic moat primarily coming from switching costs, but it also has network effects and cost advantages as secondary moat sources, and a company that we see as having exemplary capital allocation.
Dziubinski: Microsoft is held up better than quite a few other tech names this year. Why is it your top core holding in tech right now?
Sekera: One thing I really like about it, it’s very diversified, has a combination of a lot of different types of very steady-Eddie types of businesses. I think that would help cushion their business overall to the downside if we were to go into a recession. Yet it also has several different higher growth businesses, which helps earnings accelerate to the upside. When we look at its different business lines, it’s pretty much a leader in everything that it competes in. You have the personal computing business, that’s its operating system in the Xbox. You have productivity and business processes, that’s where you have Microsoft Office, Teams, and LinkedIn. You have the cloud computing business, its Azure business, enterprise services. And then of course its artificial intelligence with Copilot. Very solid balance sheet, a lot of cash on the balance sheet. Taking a look at credit ratings, I think it’s only one of two companies out there that’s still rated AAA by the agencies. Johnson & Johnson is the other. And when we look at exposure to tariffs, I think they have lower or maybe even no exposure to tariffs.
Dziubinski: All right. Your second core stock to buy is Deere DE. Tell us about this one.
Sekera: Deere trades at a little bit less of a discount, only at 9%, but that’s still enough to put it in 4-star territory because the stock is rated with the Medium Uncertainty. A little bit lower dividend yield than I’d prefer, only 1.4%. But a company with a wide economic moat, primarily coming from intangible assets and switching costs. And another company we rate with an exemplary capital allocation.
Dziubinski: What makes Deere a top core holding from the industrial sector today?
Sekera: It’s in the industrial sector, but in my mind, I still think, over the longer term, it’s still more of a defensive kind of company. Deere, of course, being a leading global supplier of agricultural equipment. They’ve got over 50% market share here in North America. And the thing is, going forward, we see their equipment being increasingly connected and relaying information to the John Deere operations center. So this provides John Deere with a huge amount of intellectual property. So they’re able to use this IP to help farmers optimize their planting, which of course then helps them save on all different types of operating costs. For example, they can then use less fuel, fertilizers, and herbicides, helps the farmers reduce labor time. So in the short term, yes, farmers can put off buying new equipment when commodity prices are low. But Deere does already have the largest installed base so you have pretty steady service revenues for repairs and things like that, as well as the fee income coming from these other businesses to help cushion it to the downside.
Looking forward, we think the increasing amount of services going forward as well as some higher fee income is going to be able to drive margins higher over time. An example our analyst here has talked about is ExactApply, uses cameras as well as a lot of GPS to really target application of herbicides that then reduces costs. And that’s part of their business chain by as much as two thirds. Lastly, it is a solid balance sheet, rated single A by the agencies.
Dziubinski: Now in the consumer defensive sector, Clorox CLX is your core pick today. Tell us about it.
Sekera: Four-star rated stock, 20% discount, 3.5% dividend yield, Medium Uncertainty, wide economic moat. That wide economic moat primarily coming from intangible assets based on their brands, but they also just have very entrenched positions with leading retailers. And then cost advantage is more of a secondary source for their economic moat. And another company that we rate with that exemplary capital allocation.
Dziubinski: Dave, how does Clorox look from a tariff perspective? Where does it fall on that vulnerability scale, and why is it your core pick in the sector right now?
Sekera: It doesn’t look like it’s going to necessarily be that adversely impacted from tariffs. Now generally, I know our analysts have noted that across the consumer defensive sector overall, a lot of firms have actually been switching up where they manufacture and putting those manufacturing facilities, in general, closer to where they sell products. And in this case, with Clorox, 85% of their sales does come from the US. So really it’d just be the retaliatory tariffs in this case that would be a concern. But with that much of their sales coming in the US, probably really not a concern when we think about their long-term earnings growth.
Clorox in and of itself, very balanced in spending on research and development, helps them drive new product innovation. Company continuously reinvests in its brands through promotional activity. So another concern here is that in a recession you could see consumers trading down to private-label products, but that type of competition is nothing new to Clorox. In fact, over time, they’ve actually gained share against private-label products. So one example our analysts highlighted was the bleach market. Their market share is now 63%. That’s up from 59% a decade ago. The company’s definitely doing the right things in how they’re balancing new product innovation as well as spending on promotional activity. Lastly, another company, pretty solid balance sheet. It’s rated Baa1 by Moody’s, BBB+ by Standard & Poor’s.
Dziubinski: All right. And your final core stock to buy comes from the utility sector. It’s NextEra Energy NEE. Tell us about it.
Sekera: NextEra, 12% discount, enough to put it in 4-star territory, 3.4% dividend yield. Company we rate with a Medium Uncertainty. Now it has a narrow economic moat as opposed to wide, but narrow economic moat is standard across our utility sector. And primarily that just comes from efficient scale, really being a regulated utility as we see with all the other regulated utilities. And another company we rate with an exemplary capital allocation.
Dziubinski: Now you know the follow-up question here, Dave: Why is NextEra your core pick in the utility sector today?
Sekera: When we look at their business, 80% of their business is just being a regulated utility down in Florida, and our analyst team has a very favorable view of the regulatory environment there for utilities. The other 20% of the business might cause some concern for some investors: That’s coming from renewable energy. But in this case the company was an early mover. They’ve locked in all the best locations for renewables, and our analyst team has noted that they can even expand those locations if warranted by the economics. They already have long-term power contracts in place to be able to sell the electricity from those renewables and essentially lock in the economics on those assets in that specific category. And lastly, just another company with a solid balance sheet, rated Baa1, A-.
Dziubinski: All right. Thanks for your time this morning, Dave. Those who’d like more information about any of the stocks Dave talked about today can visit morningstar.com for more details. We hope you’ll join us next week for The Morning Filter on Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this episode and subscribe. Have a great week.