Through the first six months of the year, the S&P 500 is up from 1462 to 1606 (9.8%), while the Morningstar value portfolio is up 6.6%.

Applied Materials (+28%), Berkshire Hathaway (+23%), Microsoft (+26%), and Western Union (+23%) stood out as winners, but the portfolio had double-digit losers in Weight Watchers (-14%) and CH Robinson (-12%) as well.  As before, many companies in the portfolio remain good values, but simply are not among the more popular or trendy stocks currently.

Although the portfolio may remain a quality long-term investment short-term performance has been mixed so far.

As it turns out, buying the “unloved” stock examples Blackberry and Netflix would have dramatically outperformed the Morningstar stock portfolio of 20 undervalued stocks through the first quarter, as the portfolio returned only 1.4%.  Note the S&P 500 was up 7.4%, and our unloved examples of BBRY and NFLX (very risky/volatile) would have been up 60%.

Although the Morningstar value portfolio did well with a few picks such as Berkshire Hathaway and Excelon (+15%), it also had poor picks like Weight Watchers (-23%) that weighed down the portfolio.  The performance difference between the hand-picked stock examples and Morningstar’s portfolio of undervalued wide-moat stocks is largely due to earnings and product announcements from BBRY and NFLX, as well as somewhat broader interest in these names than in most companies in the Morningstar portfolio.

Many of the Morningstar portfolio stocks remind me of another holding I have – China Gueri (CHOP), a Chinese specialty metal producer that is tremendously overvalued but isn’t on many people’s radar.  The price of a stock is based both on the free cash flow of the underlying company and on market sentiment, and it seems market sentiment may change with less-known stocks relatively slowly.

I’m not inclined to rebalance the Morningstar portfolio given the few changes and poor performance through the first quarter, but will revisit its performance in coming quarters.

So far, the fund has bought mutual funds and ETFs, but no stocks.  This is in part to minimize transaction costs and management complexity, and to benefit from the relative diversity offered by holding low numbers of mutual funds relative to low numbers of stocks.

While it’s tempting to buy unloved stocks such as Netflix or Blackberry hoping they’ll break out, or buy Apple based on its historic market leadership and low price/earnings ratio, building a stock portfolio can be perilous.  Many investors buy “hot” stocks once they’ve become hot, often capturing the common fall back to Earth rather than further price appreciation.  Investors who do not research stocks full-time also often hold too few stocks to build a portfolio having tolerable volatility, and tend to not dedicate the weekly time needed to follow each stock (much less to scout for potential new purchases).

I’ve recently started tracking a stock portfolio based on long-term performance of undervalued stocks selected by formula, proposed by Morningstar and said to return 17% on average.  The new stock portfolio tracks 20 stocks Morningstar estimates to have the best price/fair value estimate, and that have a “wide moat”, or significant barrier to competition.  The portfolio started the year with $500,000, equally distributed among the following stocks, and will re-evaluate quarterly:

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