This is a proprietary Morningstar data point. The Morningstar Style Box is a nine-square grid that provides a graphical representation of the "investment style" of stocks and mutual funds. For stocks and stock funds, it classifies securities according to market capitalization (the vertical axis) and growth and value factors (the horizontal axis). Fixed income funds are classified according to credit quality (the vertical axis) and sensitivity to changes in interest rates (the horizontal axis).
By providing an easy-to-understand visual representation of stock and fund characteristics, the Morningstar Style Box allows for informed comparisons and portfolio construction based on actual holdings, as opposed to assumptions based on a fund's name or how it is marketed. The Style Box also forms the basis for Morningstar's style-based fund categories and market indexes.
How It Works
The vertical axis of the Style Box defines three size categories, or capitalization bands-small, mid-size, and large. The horizontal axis defines three style categories. Two of these categories, "value" and "growth," are common to both stocks and funds. However, for stocks, the central column of the style box represents the core style (those stocks for which neither value or growth characteristics dominate); for funds, it represents the blend style (a mixture of growth and value stocks or mostly core stocks).
Style Box assignments begin at the individual stock level. Morningstar determines the investment style of each individual stock in its database. Stocks are evaluated against other stocks in the same geographic area (United States, Latin America, Canada, Europe, Japan, Asia ex-Japan, Australia/New Zealand). The style attributes of individual stocks are then used to determine the style classification of stock mutual funds.
The Horizontal Axis
The scores for a stock's value and growth characteristics determine its horizontal placement:
Value Score Components and Weights
Forward looking measures 50.0%
Price/Prospective Earnings.
Historical based measures 50.0%
Price/book 12.5% Price/sales 12.5% Price/cash flow 12.5% Dividend yield 12.5%
Growth Score Components and Weights
Forward looking measures 50.0%
Long-term projected earnings growth
Historical-based measures 50.0%
Historical earnings growth 12.5% Sales growth 12.5% Cash flow growth 12.5% Book value growth 12.5%
Growth and value characteristics for each individual stock are compared to those of other stocks within the same capitalization band and are scored from zero to 100 for both value and growth. To determine the overall style score, the value score is subtracted from the growth score.
The resulting number can range from 100 (for low-yield, extremely growth-oriented stocks) to -100 (high-yield, low-growth stocks). A stock is classified as growth if the net score equals or exceeds the "growth threshold" (normally about 25 for large-cap stocks). It is deemed value if its score equals or falls below the "value threshold "(normally about -15 for large-cap stocks). And if the score lies between the two thresholds, the stock is classified as "core."
The thresholds between value, core, and growth stocks vary to some degree over time, as the distribution of stock styles changes in the market. However, on average, the three stock styles each account for approximately one third of the total free float in each size category.
The Vertical Axis
Rather than a fixed number of "large cap" or "small cap" stocks, Morningstar uses a flexible system that isn't adversely affected by overall movements in the market. Large-cap stocks are defined as the group that accounts for the top 70% of the capitalization of each geographic area; mid-cap stocks represent the next 20%; and small-cap stocks represent the balance.
Moving from Individual Stocks to Funds
A stock fund is an aggregation of individual stocks and its style is determined by the style assignments of the stocks it owns. By plotting all of a fund's stocks on the stock style grid, the range of stock styles included in the fund immediately becomes apparent. An asset-weighted average of the underlying stocks' style and size scores determines a fund's placement in the Style Box.
Style box assignments for stocks are updated each month. Assignments for funds are recalculated whenever Morningstar receives updated portfolio holdings for the fund.
Fixed-Income Style Box
Domestic and international fixed-income funds focus on the two pillars of fixed-income performance: interest-rate sensitivity and credit quality. Morningstar splits fixed-income funds into three groups of interest rate sensitivity (high, medium, and low) and three credit-quality groups (high, medium, and low). These groupings graphically display a portfolio's average effective duration and credit quality. As with equity funds, nine possible combinations exist, ranging from short maturity/high quality for the safest funds to long maturity/low quality for the more volatile.
Along the horizontal axis of the style box lies the average term length of a fund's bond portfolio based on average effective duration. This figure, which is calculated by the fund companies, weights each bond's duration by its relative size within the portfolio. Duration provides a more accurate description of a bond's true interest-rate sensitivity than does maturity because it takes into consideration all mortgage prepayments, puts, and adjustable coupons. Funds with an average effective maturity of less than 3.5 years qualify as short term. Funds with bonds that have an average effective duration greater than or equal to 3.5 years but less than or equal to 6 years are categorized as intermediate, and those with maturity that exceeds 6 years are long term. (The duration ranges vary slightly for municipal-bond funds: Less than 4.5 years is short term; 4.5 to 7 years is intermediate; and greater than 7 years is long term.)
If duration data are not available, Morningstar will use average effective maturity figures to calculate the fund's style box. Although duration is the more accurate measurement, maturity can also be used to gauge the amount of interest-rate risk in a fund's portfolio. Funds with bonds that have an average effective maturity of less than 4 years qualify as short term. Funds with an average effective maturity greater than or equal to 4 years but less than or equal to 10 years are categorized as intermediate, and those with maturity that exceeds 10 years are long term.
Along the vertical axis of a fixed-income style box lies the average quality rating of a bond portfolio. Funds that have an average credit rating of AAA or AA are categorized as high quality. Bond portfolios with average ratings of A or BBB are medium quality, and those rated below BB are categorized as low quality. For the purposes of Morningstar's calculations, U.S. government securities are considered AAA bonds, nonrated municipal bonds generally are classified as BB, and all other nonrated bonds are considered B.
For hybrid funds, both equity and fixed-income style boxes appear.
Using the Style Box
In general, a growth-oriented fund will hold the stocks of companies that the portfolio manager believes will increase earnings faster than the rest of the market. A value-oriented fund contains mostly stocks the manager thinks are currently undervalued in price and will eventually see their worth recognized by the market. A blend fund might be a mix of growth stocks and value stocks, or it may contain stocks that exhibit both characteristics.
Understanding how different types of stocks behave is crucial for building a diversified, style-controlled portfolio of stocks or mutual funds. The Morningstar Style Box helps investors construct portfolios based on the characteristics-the style factors-of all the stocks and funds that portfolio includes.
For additional information, please see:
Morningstar Style Box Methodology
