Rather than NAV value, Morningstar begins applying discounted cash-flow (DCF) model to value REITs.
Morningstar said the new DCF model will impact the analysis and fair value estimates for all of the 61 REITs the firm covers. Before applying the new model, Morningstar considered all REIT stocks it covered overvalued. Under the new DCF model, Morningstar now considers 10 of the 61 stocks undervalued. Investors can find the new proprietary methodology at Morningstar.com.
“Although buildings add a tremendous amount of intrinsic value to a REIT, the stock market still cares about the company’s management, cash flows and earnings,” said Patrick Dorsey, director of stock analysis for Morningstar. “Managers can create or destroy value for shareholders as a result of their actions. We think the discounted cash-flow model is the better method for determining the worth of REIT stocks, and for individual investors to make buy/sell decisions.”
Morningstar stock analysts look at cash flow, earnings, buildings’ value, and regulatory constraints as part of their assessment of REIT stocks. They also consider management decisions and other intangibles, though these typically account for only 15 percent to 20 percent of the overall value of the stock — which indicates the primary importance of the intrinsic value of a REIT’s buildings, Morningstar said.