(PUB) Investing 2016

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

200

mostly

large-cap names they cover. A stock with a price/

fair value ratio greater than

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

and

remained overvalued through

2014

, ending the year

Vanguard 500 Index

VFIAX

also had a price/

fair value ratio of

at the end of

2014

. That was

up considerably from its

ratio at the end of

2012

—

before the

2013

surge.

As of Sept.

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

. Vanguard

500

Index was also at

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

or higher. Today,

50%

of large-cap funds are still fully valued or overvalued,

and most of the rest are close.

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.

, but

American

Funds Washington Mutual

AWSHX

, which aims for a

dividend yield higher than the S

500

’s, still clocked

in at

, as did

Columbia Dividend Income

GSFTX

Vanguard High Dividend Yield Index

VHDYX

was

up there, with a price/fair value ratio of

. The best

value in the category was Silver-rated

Invesco Com-

stock

ACSTX

. 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

. 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

. 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

keeps

75%

of assets in dividend-paying names. But

the managers don’t emphasize high dividends or

Are Large Caps Overpriced?

Morningstar Research

Laura Lallos