Foolish Forecast: Will Morningstar Miss?

In its short life as a publicly traded company, mutual fund rater (and now stock rater, too!) Morningstar (Nasdaq: MORN  ) has thrice missed analyst estimates, tied once, and "beat" four times. So if Morningstar misses its Q3 2007 estimates tomorrow, Jedi Knights can rejoice in balance being restored to the Force. Investors, however, might be a bit peeved.

What analysts say:

  • Buy, sell, or waffle? Two analysts follow Morningstar, both rating it a hold.
  • Revenues. On average, they're looking for 37.5% sales growth to $112.5 million.
  • Earnings. Profits are predicted to climb 34% to $0.39 per share.

What management says:
Once again, we turn to Morningtar's monthly roundup of investor-submitted questions for some insight into its business. As you'll recall, last quarter we learned from this source that the firm considers McGraw-Hill (NYSE: MHP  ) and Thomson Corp (NYSE: TOC  ) its two most significant publicly traded rivals, and that units of Time Warner (NYSE: TWX  ) , Dow Jones (NYSE: DJ  ) , Microsoft (Nasdaq: MSFT  ) , and Yahoo.com (Nasdaq: YHOO  ) also compete with its various businesses.

Today, let's review a question on one of the lesser-known of those businesses. Quick -- when you think of Morningstar, what business pops first into mind? That's right: rating mutual funds. But did you know that Morningstar is a sort of mutual fund itself and also advises the same funds it rates? Responding to an investor request to "explain the difference between assets under management vs. advisement," Morningstar clarified with this:

"We use assets under management to refer to assets we manage directly, such as with Morningstar Managed Portfolios and the managed retirement accounts that are part of our retirement advice platform. Assets under advisement refers to assets on which we provide ... advice but for which we don't have direct discretionary investment authority." In that capacity, Morningstar advises other investment firms on where to invest their money. "For example, we provide asset allocation and fund selection services for numerous funds of funds, and we include these assets in our total assets under advisement, which totaled about $81.5 billion as of June 30, 2007."

What management does:

The former activity falls within the firm's "advisor" segment, the latter is classified "institutional," and they're both very important to the business, generating above-average operating margins of 34.5% and 48%, respectively, in fiscal 2006.

Margins

3/06

6/06

9/06

12/06

3/07

6/07

Gross

72.5%

72.1%

72.4%

72.4%

72.4%

73%

Operating

24.1%

23.9%

24.7%

24.6%

24.2%

25%

Net

16.6%

16%

16.7%

16.4%

15.9%

16.4%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
A couple of quarters back, I mentioned that Morningstar has been on a bit of a buying spree, but the businesses it had been buying had been dragging margins down -- a trend that management promised to reverse "over time as Morningstar integrates these new businesses into its operations." As you can see in the table above, management began to deliver on that promise last quarter, yanking margins up at all three levels -- gross, operating, and net.

Judging from the analysts' expectations described above, it seems no one on Wall Street believes this recurred last quarter, as profits growth is expected to lag revenues growth. The logical conclusion is that Morningstar's two analysts believe that margins contracted last quarter. Personally, I wouldn't be surprised to see them proven wrong. As Morningstar gets bigger and gains ever-greater scale in its operations, the logical consequence of that is for margins to expand. Who's right and who's wrong? Tune in tomorrow to find out.

What did we expect to see at Morningstar last quarter, and what did we get? Find out in:


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