(PUB) Investing 2015

January 2 015

Morningstar FundInvestor

11

Are Large Caps Getting Pricey? Red Flags | Laura Lallos

Large Value Investors hungry for income and security have been favoring solid dividend-payers for the past several years. Two years ago, the priciest funds in the category were dividend-oriented strategies, and the same is true today. But this time these funds had price/fair value ratios greater than 1 . 0 . Columbia Dividend Income GSFTX was again among the priciest in the category, with a ratio of 1 . 03 (compared with 0 . 98 two years ago). It was tied with TCW Relative Value Dividend Appreciation TGIGX , and Vanguard High Dividend Yield Index VHDYX was close behind. Large Blend Dividend-oriented funds were among the most over- valued here, too. Amana Income AMANX was again one of the most expensive, with a ratio of 1 . 06 . It holds only dividend-paying stocks and has avoided financials—which are undervalued by this measure— to abide by Islamic prohibitions on interest. Fidelity Dividend Growth FDGFX had a ratio of 1 . 03 , reflect- ing its new manager’s strict focus on high-dividend picks. Parnassus Core Equity PRBLX came in at 1 . 03 , too. Oakmark OAKMX and Oakmark Select OAKLX had among the lowest ratios in the category, around 0 . 99 —manager Bill Nygren has eschewed high-yield picks. Large Growth As expected, most of these topped the list overall. Two years ago, however, about one third of the cate- gory had price/fair value ratios below 0 . 95 . Now only one ( RiverPark/Wedgewood RWGFX ) was below 1 . 0 . Amana Growth AMAGX was one of the most expen- sive at 1 . 10 , reflecting its heavy overweighting in technology and its great run for the year. The same goes for Fidelity Growth Company FDGRX , at 1 . 08 . Marsico Focus MFOCX clocked in with a ratio of 1 . 07 . The take-away? This valuation snapshot is no reason to sell, or even avoid, these funds. But it may be time to check in and rebalance. If you are buying, dollar-cost average in—these funds may be better values in the future. œ

Many large-cap U.S. equity funds saw losses in December, but most ended 2014 with double-digit gains. Are they now overvalued? Morningstar’s stock analysts have developed a measure of fair value, using a proprietary discounted cash flow model to assess the more than 1 , 200 mostly large-cap names they cover. A stock with a price/fair value ratio greater than 1 . 0 is considered overvalued. This is not a perfect predictor for timing purposes, but it does give some sense of overall value. At the end of 2013 ’s rally, the median stock covered by Morningstar had a price/fair value ratio of 1 . 06 . It remained overvalued through much of 2014 and ended the year at 1 . 03 . That’s not a bargain, and it’s higher than it was the last time we calculated this ratio for Morningstar 500 funds at the end of 2012 . At that point, the median stock that Morningstar covered had a price/fair value ratio of 0 . 94 , and the ratio for Vanguard 500 Index VFIAX was 0 . 93 . As we did last time, we calculated a price/fair value ratio for all the large-cap funds in the Morningstar 500 . (We limited the search to those funds for which we had a recent portfolio and fair value figures for at least 75% of the portfolio.) As of mid-December, Vanguard 500 Index was at 1 . 03 . As might be expected, the funds with the highest ratios were generally growth funds. However, both growth and value funds were still much more richly valued than they were at the end of 2012 . More than 80% of the funds had ratios of 1 . 0 or higher. Two years ago, none of the large-value funds on the list were fully valued; this time, only a third were priced below our calculation of fair value.

What is Red Flags? Red Flags is designed to alert you to funds’ hidden risks. Such risks can take many forms, including asset bloat, the depar- ture of a solid manager, or a focus on an overhyped asset class. Not every fund featured in Red Flags is a sell, and in fact, some are good long-term hold- ings. But investors should be prepared for a potentially bum- pier ride in the near future.