Tariffs and Stock Valuations: Answering Your Questions

Senior US Economist Preston Caldwell and Senior US Market Strategist David Sekera hosted a webinar on April 8 where they discussed their updated economic and market outlooks. Webinar viewers submitted several questions—questions that merit a thoughtful response. Hopefully, our answers will provide insight into our methodology and process, as well as what goes into our investment decisions.

How do macroeconomic events, like the recent tariff increases, factor into Morningstar’s equity ratings?

We take our economic research team’s views into account in our valuation work, but there’s no mechanical link. We recognize that the short-term macroeconomic backdrop can be very important for certain industries, like banks, and in certain situations, such as heavily indebted companies, but long-term industry- and company-specific fundamentals are almost always more important drivers of our fair value estimates.

Morningstar believes that the market is undervalued now, a take I haven’t heard much in the US. What is Morningstar seeing that no one else is?

While other research firms focus on what will happen in the next quarter, our methodology is designed to prioritize the long term.

Valuations have pulled back when using traditional multiples such as price/earnings or price/book value, but by those same measures, they would not be considered cheap when compared with historical averages. With that said, for many companies in our coverage, growth rates, profit margins, and returns on invested capital have risen above long-term averages while capital intensity has been reduced.

In a situation like this, the valuation implied by our fair value estimates may appear “expensive” using traditional metrics. While we are aware of different valuation metrics, we focus on the fundamentals within our discounted cash flow model that is anchored to our moat ratings.

Does the current fair value account for the impact of tariffs and greater uncertainty?

Some of our analysts’ forecasts have begun to embed higher uncertainty levels, as reflected in our Uncertainty Ratings. This is done on an analyst-by-analyst and company-by-company basis. We are generally averse to making blanket changes to our Uncertainty Ratings.

Are we missing the forest for the trees here? These are not normal times. We are watching the US fall from a global economic leader to a self-isolated nation. Why wouldn’t we consider the impact of the recent actions from the US government in market valuations?

We are indeed living in a period of uncertainty both in the US and from a global geopolitical perspective. But we believe that the US is still grounded in its constitutional framework and strong governing institutions.

While the system of checks and balances has been tested, we think it has withstood the test of time. Our very long-term outlook is still generally positive for the US from a macroeconomic and political standpoint because the US is still the world’s leading democracy; it has increased its gross domestic product at a steady pace for years; it still enjoys a unique leadership position in technologies of the future; and it maintains the world’s reserve currency, all of which contribute to macroeconomic stability.

Specifically, considering the impact of recent actions from the US government on market valuations, we’d make the following observations: First, it’s important to distinguish between statements, press releases, and tweets versus enacted policy; second, when policies are enacted, it’s essential to consider the effects, and we do. In this case, it appears that we are still in the early stages of enacting actual policy, with many countries approaching the negotiating table.

Is your analysis completely agnostic to tariffs? For example, Hershey imports a lot of its ingredients.

We are not completely agnostic to tariffs. Our analysts test various economic scenarios, including tariffs, and base their estimates on the best information available. We tend to wait until policy decisions are clear before we embed the policy itself into our base-case forecast.

The tariffs announced by the Trump administration were highly aggressive compared with the market’s expectations: The breadth and scope of the announced tariffs surprised the market. Tariffs were applied unilaterally on all countries and all goods. Having said this, the tariff story remains highly uncertain, as seen in the announced 90-day pause.

Our approach has been to analyze the tariffs and incorporate the most likely outcomes.

In response, we took a deep look at a number of stocks with high exposure to tariffs, with the goal of providing a window into a specific group of companies significantly affected by them.

When discussing “longer-term intrinsic value,” what is your definition of “long-term”?

Our discounted cash flow valuation model incorporates a long-term forecast in three stages.

• Stage one, our explicit forecast period, ranges from five to 10 years.
• The length of the stage two forecast period can vary; it is estimated by each analyst seeking to model, for each company, a period over which returns on newly invested capital gradually and linearly revert toward the company’s weighted average cost of capital. This can range from zero to 15 years.
• Stage three of the model represents a perpetuity value, where excess returns on new invested capital are zero. Our analysts’ estimates of fair value represent the sum of the present value of these estimated cash flows, less adjusted net debt.

We typically expect that share prices will revert to our fair value assessment within three years, on average. Sometimes, the reversion period is longer than three years, and sometimes less than three years.

Focus on Companies’ Economic Moats

While headlines about tariffs and trade tensions can trigger short‐term market volatility, investors should focus on companies’ enduring competitive advantages, or economic moats, which help maintain long‐term excess earnings. Thorough fundamental analysis and diversification are key to spotting genuine opportunities amid temporary mispricing.