(PUB) Investing 2016

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Are Large Caps Overpriced? Morningstar Research | Laura Lallos

Less Value in Large-Cap Value Break it down further, though, and the results look different than they did at the end of 2014 . Back then, while both growth and value funds were richly valued, the funds with the highest ratios were gener- ally growth funds, with large-value funds offering better deals. Today, most of the relatively few funds priced at 96% or less of fair value are large-growth funds. Meanwhile, most of the large-value funds in the M 500 are at 99% or more of fair value. With interest rates at record lows, investors hungry for income and security have been favoring solid dividend-payers for the past several years, and divend- oriented strategies have been the priciest funds within the large-value Morningstar Category since before 2013 ’s rally. Going into September, dividend strategies tended to be the priciest of all funds, period. They’d lost some value by Sept. 23 , but American Funds Washington Mutual AWSHX , which aims for a dividend yield higher than the S & P 500 ’s, still clocked in at 1 . 03 , as did Columbia Dividend Income GSFTX . Vanguard High Dividend Yield Index VHDYX was up there, with a price/fair value ratio of 1 . 02 . The best value in the category was Silver-rated Invesco Com- stock ACSTX at 0 . 95 . The deep-value strategy has much more than its typical category peer in financials, one of the poorer-performing sectors during the past year, and little in utilities, a dividend-seeker’s favorite and one of the top-performing sectors. Blend Funds Across the Spectrum With the broad market index funds generally fully valued, many large-blend funds come in with price/ fair value ratios at or near 1 . 0 . The priciest are those with an explicit dividend-growth bent, including Vanguard Dividend Appreciation Index VDAIX and T. Rowe Price Dividend Growth PRDGX , which had ratios of 1 . 04 . This underlines the point Greg Carlson made in the September issue of FundInvestor on high valuations in such strategies. The best deals are in quirky, focused portfolios that prioritize value. Silver-rated Parnassus Core Equity PRBLX , which has a price/fair value ratio of 0 . 96 , keeps 75% of assets in dividend-paying names. But the managers don’t emphasize high dividends or

After a heady rally in 2013 and double-digit gains in 2014 , large-cap funds were clipped in 2015 . Now that they’ve regained some ground so far in 2016 , are there decent deals to be had? We decided to answer that question using our fair value estimates to assess the overall market and find the best bargains. Morningstar’s equity analysts have developed a measure of 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 over- valued. 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 and remained overvalued through 2014 , ending the year at 1 . 03 . Vanguard 500 Index VFIAX also had a price/ fair value ratio of 1 . 03 at the end of 2014 . That was up considerably from its 0 . 93 ratio at the end of 2012 — before the 2013 surge. As of Sept. 23 , 2016 , U.S. stocks were still less expensive than they were going into 2015 . The median stock covered by Morningstar was fully but not excessively valued in mid-September, with a price/fair value ratio of 1 . 0 . Vanguard 500 Index was also at 1 . 0 . That does not mean most large-cap funds are now priced just about right. The median and the bench- mark ratios obscure the extremes. 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 we observed in the January 2015 issue of Morningstar FundInvestor , more than 80% of the funds in our sample back then had ratios of 1 . 0 or higher. Today, 50% of large-cap funds are still fully valued or overvalued, and most of the rest are close.