The following article is a special edition of Your Money Weekly that is normally only available for Morningstar subscribers.

Our US colleagues recently hosted a webinar where they discussed their updated economic and market outlooks. Naturally, investors over there were eager to understand how Morningstar incorporates such extreme economic uncertainty into its research, and they asked some thoughtful, probing questions.

I expect many of our Australian subscribers are wondering the same. So this week, inspired by the questions from our US clients, we’re turning the focus homeward to explore these issues through an Australian lens. I hope the 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?

Our economic research team has downgraded its US growth forecasts and raised its inflation outlook in the wake of the tariff announcements. While our equity analysts consider these macro forecasts in their valuation work, there’s no mechanical link. We recognise that the short-term macroeconomic backdrop can be very important for certain industries, but long-term industry- and company-specific fundamentals are almost always more important drivers of our fair value estimates.

So, is your analysis of companies completely agnostic to tariffs?

No, it isn’t. Where tariff impacts are visible and significant, we incorporate them. But we need to keep things in perspective.

Let’s illustrate with a simple example: Breville (ASX:BRG), a manufacturer of kitchen appliances. Our fair value estimate for Breville—like our valuation for all companies we cover—is the sum of cash flows we expect the business to generate in the future, discounted to today. We discount these cash flows to account for the ‘time value of money’—the observation that a dollar today is worth more than a dollar tomorrow.

As a manufacturer of appliances in China, Breville is unfavourably exposed to tariffs. About 40% of revenue is directly affected. Although price increases should offset some of the damage, we expect a hit to sales and margins in the short term. All up, we have reduced our fiscal 2026 operating earnings forecast by 5%.

But let’s put this into context. Breville‘s estimated cash flow for fiscal 2026 accounts for about 3% of our valuation for the business. In isolation, reducing this by 5% has a negligible impact on our fair value estimate.

The bigger question is whether Breville‘s earnings outlook is permanently impaired. If next year’s earnings account for 3% of our valuation, then the other 97% must be made up by fiscal 2027 and beyond. After all, stocks are perpetual securities, entitling investors to an infinite stream of cash flows if the business remains a going concern.

We believe a company’s long-run earnings potential is primarily determined by the durability of its competitive advantages, or economic moat. Eventually, competition should eat away at the excess returns of every business. But the longer a business can stave off this competition, the more we should be willing to pay for it, all else equal. For readers looking for a deeper dive, my colleague Mark LaMonica has put together a thorough discussion in his article ‘How to find a great company to buy’.

We don’t think Breville‘s moat has been impaired by Trump’s tariffs. It’s premium brand perception, and the pricing power this affords, remains. We also think the company can diversify its manufacturing away from China, which should limit the downside to earnings for as long as tariffs remain in place.

So, although we’ve cut near-term earnings, the isolated impact on our valuation is negligible. The long-run outlook is far more important—and we haven’t changed our view on this. So, our fair value estimate for Breville stands. The stock is down about 10% since April 2nd, and although it still looks overvalued, this severe reaction to tariffs is probably unwarranted.

Are Australian equities still overvalued after the tariff volatility?

It depends on how we look at it.

The Australian market remains expensive on a market-cap weighted basis, at a price/fair value ratio of 1.17—a 17% premium. But in a cap-weighted index, larger companies have considerably greater representation. Our blue chips, and especially banks, have looked overvalued for some time and continue to do so. CBA, which alone accounts for about 10% of the ASX 200, trades at a near 70% premium to fair value. Its shares have shrugged off the tariffs, up 8% since April 2nd.​

But looking at the market on an equal-weighted basis—that is, giving each company, small or large, the same weighting in the index—our coverage trades at price/fair value of 0.98. It’s a slim 2% discount, and we’d consider this fairly-valued territory.

This was not so before the tariffs. At the start of 2025, our coverage traded at an equal-weighted premium of about 8%, so the selloff has uncovered many more opportunities, particularly at the smaller end of our coverage.

Have you incorporated greater uncertainty into your fair value estimates?

Some of our analysts, particularly in the US where the effects are most direct, have increased their Uncertainty Ratings on stocks. This doesn’t necessarily mean they’ve changed earnings forecasts, but we now need a wider margin of safety before classifying the stock as undervalued (4- or 5- star rated). 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?

Though this question is not explicitly directed to the Australian market, some readers will own US stocks. And many ASX-listed companies own businesses in the US, so it’s important to consider whether we are witnessing ‘the end of US exceptionalism‘. Here’s our take.

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.

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. Companies with wider moats have a longer stage two forecast period, reflecting our assumption that they can generate excess returns longer than less-moaty businesses.

Stage three of the model represents a perpetuity value, where excess returns on new invested capital are zero.

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.

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