In its short life as a publicly traded company, mutual fund-rater (and now stocks, too!) Morningstar (NASDAQ:MORN) has thrice missed analyst estimates, thrice beaten them, and tied once. Thus was balance restored to the universe last quarter. Will Thursday's Q2 news upset it?

What analysts say:

  • Buy, sell, or waffle? Only two analysts follow Morningstar, splitting their votes buy/hold.
  • Revenues. On average, they're looking for 31.5% sales growth to $100.3 million.
  • Earnings. Profits are predicted to spike 42% to $0.34 per share.

What management says:
I've mentioned in the past how impressed I am with Morningstar's nearly unique habit of inviting direct inquiries from shareholders, answering them clearly, and publishing the answers in monthly 8-K filings with the SEC. (Impressed enough that, yes, as you'll see in my disclosure below, I finally bit the bullet and invested in Morningstar.)

These 8-K filings give investors special insight into the workings of the firm, and July's filing was no exception. There, Morningstar addressed the question of its competitive landscape. Granted, this information is contained in its annual 10-K filing, but considering that the shareholder inquiring about it probably hadn't read it -- and that a lot of us don't read these filings as we should, either -- I think it's worth going over here.

According to Morningstar, its two biggest publicly traded rivals are business units of McGraw-Hill (NYSE:MHP) and Thomson Corp (NYSE:TOC). Within Morningstar's "individual" business segment, rivals include units of Time Warner (NYSE:TWX), Dow Jones (NYSE:DJ), Microsoft (NASDAQ:MSFT), TheStreet.com, and Yahoo.com (NASDAQ:YHOO). Rivalry in the firm's two other key business segments, "advisor" and "institutional" add FactSet and Wilshire to this list. Morningstar also competes with a host of privately held companies, The Motley Fool among them.

What management does:
Has Morningstar passed its zenith? Lately, the competition above seems to have taken a toll on the company. Rolling gross margins dipped last quarter, and both rolling operating and net margins have slipped for two quarters straight. While Morningstar's citing of "our relatively small size compared with our competitors" as a key business risk is repeated by rote in most companies' 10-K filings, in Morningstar's case, it just might be worth paying attention to.

Margins

12/05

3/06

6/06

9/06

12/06

3/07

Gross

72.3%

72.9%

72.6%

72.8%

72.8%

72.7%

Operating

26.0%

28.1%

27.7%

28.5%

28.2%

27.6%

Net

13.7%

16.6%

16.0%

16.7%

16.4%

15.9%
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:
Then again, as I mentioned two months ago, Morningstar has been buying up complementary businesses in recent quarters, and some of these businesses simply operate on lower margins than did the core business. Considering how small the changes in margins above are at present, the addition of sizable new businesses operating at lower levels of profitability could as easily explain the margin contraction, as would increased competition.

In that regard, Morningstar reassured us last quarter that "the company believes these margins will improve over time as Morningstar integrates these new businesses into its operations." Now that the businesses have been brought into the fold, we'll want to see actions matching Morningstar's words. We'll want to see the margins rising from where they now sit. Else, another explanation for the margin contraction must be sought.

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Fool contributor Rich Smith owns shares of both Morningstar and TheStreet.com. The Fool has a disclosure policy.