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Morningstar.com's Interactive Classroom

Course 402
Morningstar's Stock Types

Introduction

Microsoft MSFT and Microtest MTST have two things in common: They're both technology companies, and they both have "micro" in their names. But that's where the similarities end. One is the most successful company of the 1990s and the largest company in Morningstar's stock database, with a market value of $450 billion at the end of 1999. The other, a struggling producer of hand-held scanners, is worth a piddling $30 million, making it the 5,933rd largest company we track. Two technology companies, two very different stocks. Inside any sector--whether it's technology or utilities--you'll find companies as different as Microsoft and Microtest. We developed Morningstar stock types, which can be found on the Morningstar Stock Report, to highlight fundamental differences between companies. We examine each company's historical record, growth rates, cash flows, and other financial data, and assign it to one of eight groups. These stock types address the question: What kind of company is this? What about Microsoft and Microtest? Bill Gates' company lands in our aggressive-growth stock type, the home of the fastest-growing companies in our database. Microtest doesn't fare so well. Because of declining cash flows and negative earnings, it's in the distressed group. Hawking handheld cable scanners hasn't generated much growth.

Let's Make a Distinction

Savvy investors know about the corporate life cycle: Companies in their startup phase lose money; if they're successful, though, they enter a rapid growth period, where sales--and eventually profits--shoot upward. Then, alas, comes the point when the company has exhausted all of the easy growth opportunities. The low-hanging fruit has been picked. The company enters a mature phase in which sales may be growing, but at a much slower rate than before. Finally, in a company's dotage, it's all management can do to grow the company at all. The company's either in stagnation or outright decline. Our stock types help you pinpoint where a company is in the life cycle. Let's look at semiconductors. What's the key difference between chipmakers Intel INTC and National Semiconductor NSM? Or between Broadcom BRCM and Rambus RMBS? One of the babies of the industry is Rambus, a company that makes devices to speed up computer processing. The company's sales have grown rapidly, though inconsistently. Earnings have been even spottier. Rambus has actually lost money over the past five years in aggregate. It is a great example of a speculative-growth company. Moving up the maturity scale a notch we find Broadcom, a company about 10 times the size of tiny Rambus. The company specializes in chips that enable broadband data communication. Broadcom's sales have grown rapidly, and although it has had one money-losing year over the past five years ending in 1999, it's generally increased its earnings in line with sales. That's the sign of an aggressive-growth company: one that has managed to increase both sales and profits at a rapid clip. Now we come to companies like industry leader Intel. Not too long ago, Intel landed in the aggressive-growth group along with firms like Broadcom, but because of slowing growth, Intel has mellowed into a classic-growth company. Despite the snags of late, Intel has a record of good sales growth and consistently positive earnings. That's the mark of a classic-growth firm. Don't expect them to grow sales by double digits every year, but do expect them to generate solid profits--and maybe even pay out a good dividend. Even more mature than Intel is Texas Instruments TXN. The company was busy restructuring itself in the late 1990s and has been shrinking as a result. The company's trailing three-year sales growth at the end of 1999 was negative, and earnings have bounced all over the place. Texas Instruments merits a slow-growth tag because of this rather unspectacular record. The trials at Texas Instruments, however, are nothing like those at chipmaker National Semiconductor. The company's sales and cash flows have fallen, and the firm has lost money as a result. The situation is bad enough to land National Semiconductor in the distressed stock type--the nether-zone in which we place firms with a history of serious operating problems. These are typically companies that have run into growth problems, either because the market is saturated or because competitors have the upper hand.

So You Want to Build a Portfolio?

The Morningstar stock types do more than just summarize a lot of financial data in order to give a bird's eye view of a company. They are tools to help analyze a stock portfolio and to see how diversified it is across different types of businesses. Over the next eight lessons, we will take a look at a well-known company in each of the stock types. Here's a quick overview of these very different companies. Speculative Growth: Yahoo YHOO. The premier Internet portal has become one of the giants of the online world, with an audience in the tens of millions. It has become consistently profitable, unlike most of its online brethren, but its track record is still so short that it is definitely risky. Aggressive Growth: Starbucks SBUX. The coffee chain has grown like gangbusters while also showing a healthy profit, the two most important characteristics of an aggressive growth stock. Classic Growth: McDonalds MCD. The fast-food giant is a stereotypical classic growth stock: A well-known name with an established track record. It's growing steadily, but not as fast as speculative growth or aggressive growth companies. Slow Growth: Procter & Gamble PG. The consumer-products giant is a good example of this type; its growth is slower than that of even classic-growth companies, but it makes up for this lack of growth with high profitability. High Yield: Philip Morris MO. The food and tobacco giant's stock was hammered in 1999, but the company still gives back much of its enormous cash flow to shareholders in the form of a hefty dividend. Cyclicals. United Technologies UTX. This industrial conglomerate is a great example of a cyclical stock. Its businesses--aerospace equipment, air conditioners, and elevators--are highly sensitive to the performance of the general economy. Hard Assets. Barrick Gold ABX. This company is one of the most consistently profitable gold-mining stocks, but it also illustrates many of the characteristics unique to companies that sell hard assets such as minerals or oil. Distressed. Silicon Graphics SGI. This maker of computer workstations and server systems was once a hot technology stock, but it has suffered through a lot of problems since the mid-1990s and has seen its stock price tank.

I Own What?

Using the stock types, analyze your own portfolio. What you find may surprise you. You might have a portfolio heavily weighted toward economically sensitive cyclicals or toward risky, untested speculative-growth firms. To do your own research on stock types, go to the Quicktake Report of any company. (Type the ticker in the Quicktake Quotes & Reports box, then click on Snapshot in the left-hand navigation bar.) Using these eight guideposts, you might discover that you've been an aggressive-growth investor, or maybe a cyclical investor, without realizing it.

Quiz 402
There is only one correct answer to each question.

1 The main purpose of Morningstar's stock types is to:
a. Find the most undervalued stocks.
b. Highlight fundamental differences between companies.
c. Identify stocks that have performed the best.
2 Startup, rapid growth, maturity, and decline are:
a. Stages of the corporate life cycle.
b. The four Morningstar stock types.
c. The four main types of investors.
3 When an aggressive-growth company's sales slow down, it will generally turn into:
a. A speculative-growth company.
b. A classic-growth company.
c. A cyclical company.
4 A company with serious operating problems will land in which stock type?
a. Speculative Growth.
b. Cyclical.
c. Distressed.
5 How can Morningstar stock types be useful in analyzing a portfolio?
a. They can help predict the portfolio's returns over the next year.
b. They can help show how expensive the portfolio is.
c. They can help show whether the portfolio is too heavily weighted toward any one type of stock, such as cyclicals or speculative growth companies.
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