Moat Stocks Maintain Lead Through Turbulence

Despite the retreat across equities in February, Morningstar's Moat and SMID Moat Indices kept their lead over various market cap segments year-to-date.

After a strong January, where benchmark U.S. stock indices had their best starts to a year in recent memory, investors were decidedly less cheery in February. Equities retreated during the month amid signs that inflation is declining less quickly than anticipated, tight labor markets are not easing and consumer spending has remained robust. All of these factors are helping to maintain price pressures and leading to concerns that we may not be as close to a U.S. Federal Reserve pivot as some initially thought.

The flagship Morningstar Wide Moat Focus Index (the "Moat Index") and its more nascent small- and mid-cap focused counterpart, the Morningstar US Small-Mid Cap Moat Focus Index (the "SMID Moat Index"), did not escape the market volatility. Both the Moat and SMID Moat Indices were down in February (-2.72% and -3.27%, respectively), slightly lagging the broader benchmarks during the month. However, despite the turbulence, both Moat Indices maintained their year-to-date lead over the various market cap segments of the U.S. stock market.

Moat Stocks Remain Ahead for the Year

Year-to-Date Total Return as of 2/28/2023

Meta Shines in a Turbulent Month

In the face of a volatile and mostly down market environment, there were still several bright spots within the Moat Index during the month. Most notable is Meta Platforms (META), which was the Moat Index's top contributor in February. META shares soared over 17% in February, following a positive earnings release that saw better-than-expected revenue and the appearance of a renewed focus on primary business lines instead of CEO Mark Zuckerberg's metaverse future. Other top contributors include cybersecurity corporation Fortinet (FTNT) and software/chip company Nvidia Corp. (NVDA). On the reverse side, detractors to Moat Index February performance landed primarily within the Industrials, Consumer Discretionary and Materials sectors.

Top Contributors and Detractors from Moat Index - February 2023

Source: Morningstar, February 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

Moat Stock Highlight: AI Craze Drives Nvidia

Nvidia Corp. (NVDA)¹ is the top designer of discrete graphics processing units (GPUs) used in a variety of end markets, including PC gaming, data centers and the now extremely fast-growing artificial intelligence (AI) market. It was the top performing stock in the Moat Index for February. Nvidia's wide economic moat stems from its intangible assets related to the design of its GPUs. NVDA has captured the lion's share of the GPU market, which has significant barriers to entry in the form of advanced intellectual property, making it unlikely that rivals will be able to compete. Additionally, Nvidia has a large research and development budget relative to AMD and smaller GPU suppliers, which allows it to continuously innovate and fuel a virtuous cycle for its high-margin chips.

NVDA was up during the month following higher quarterly revenues than expected and the recent explosion of popularity in AI models, like OpenAI's ChatGPT, or Google's (GOOG) (GOOGL) newly launched competitor, Bard. Artificial intelligence represents one of the biggest growth opportunities for the semiconductor industry, and many believe Nvidia is in a prime position to grow from it.

NVDA's share price gained over 18% in February to end the month at about $230 per share, which now puts the stock above Morningstar's estimate of fair value of $200. NVDA had traded at a 20% discount as recently as December of last year.

Small-Caps Hold Their Ground

With small- and mid-cap (SMID-cap) stock valuations at multi-decade lows compared to large-caps and shifting market dynamics, we believe SMID-caps may deliver on this historic return premium over large caps in 2023. In the SMID-cap U.S. equity segment in February, stocks fared in line with or slightly better relative to large-caps. Small-caps, demonstrated by the Russell 2000 Index, actually held up better in the down market this month than both mid-caps and large-caps. This is despite the higher levels of volatility that is generally expected in smaller companies.

Within the SMID Moat Index, top contributors for February include the power management solutions company Monolithic Power Systems (MPWR), the global supply chain solutions provider WESCO International (WCC) and BorgWarner Inc. (BWA), an automotive manufacturer and supplier. Sectors that detracted the most from SMID Moat Index performance during the month were Health Care, Communication Services and Materials.

Top Contributors and Detractors from SMID Moat Index - February 2023

Source: Morningstar, February 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

SMID Moat Stock Highlight: Monolithic Power

One of the few stocks that is currently found in both the Moat and SMID Indices is Monolithic Power Systems Inc. (MPWR)². As a reminder, the Moat Index is technically an all-cap strategy; however, it tends to bias towards large-caps due to its mandate to target only wide moat companies. MPWR is an analog and mixed-signal chipmaker, specializing in power management solutions. The firm's mission is to reduce total energy consumption in end systems, and it serves the computing, automotive, industrial, communications and consumer end markets. MPWR uses a fabless manufacturing model, partnering with third-party chip foundries to host its proprietary process technology.

Morningstar believes Monolithic Power Systems is a disruptor in the power management chip market, using its proprietary process technology to differentiate from larger competitors. MPWR boasts a wide economic moat, as a result of intangible assets from its innovative chip designs and advancements in manufacturing as well as switching costs for its integrated power management chips.

Monolithic Power Systems was a top performer in both Moat and SMID Moat Indices as its share price gained nearly 14% in February to end the month at about $485 per share. Morningstar currently estimates MPWR's fair value to be $562 per share.

Accessing Moat Stocks

VanEck Morningstar Wide ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.

VanEck Morningstar SMID Moat ETF (SMOT) seeks to track as closely as possible, before fees and expenses, the price and yield performance of the Morningstar US Small-Mid Cap Moat Focus Index.

Important Disclosures

¹ 1.96% of the Moat Index as of 2/28/2023.

² 1.54% of the Moat Index and 1.52% of the Moat Index as of 2/28/2023.

Source for all data unless otherwise noted: Morningstar.

Fair value estimate: the Morningstar analyst's estimate of what a stock is worth. Price/Fair Value: ratio of a stock's trading price to its fair value estimate.

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