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Announcing Morningstar's CEO of the Year Finalists

Todd Wenning

At Morningstar, analysis of management's capital-allocation decisions is at the heart of our stewardship methodology. While management itself cannot constitute an economic moat, we believe management’s capital-allocation decisions can lead to the establishment, enhancement, or erosion of an economic moat. Put another way, we want to better understand the intersection of management and moat with each company we research.

Rather than focus solely on corporate governance practices--though they're still important--our stewardship methodology places more emphasis on management's record on items such as financial leverage, investment strategy, investment timing and valuation, dividend and share-buyback policies, execution, compensation, related-party transactions, and accounting practices. We find these factors not only to be universally applicable for comparing stewardship across global markets, but also to better reveal how well management teams are allocating shareholder capital to enhance or establish an economic moat.

Using our stewardship methodology as a guide, we've looked across our coverage universe to select three outstanding leaders as finalists for our 15th annual CEO of the Year award.

The first finalist is Darren Gee, CEO of Canadian energy company Peyto Exploration & Development (PEY). Morningstar energy analyst Rob Bellinski believes that Gee is deserving of the award, as the company has become the lowest-cost gas producer in North America thanks to "a combination of extremely selective acreage acquisitions, ownership of gathering and processing infrastructure to reduce operating costs, and assiduously maintaining capital efficiency in building new production." An example of Gee's effective capital allocation decisions is the move Peyto made in 2012 to direct capital spending away from increasing gas capacity and toward deep-cryogenic processing as natural gas prices troughed. This decision, along with the company's established low-cost position, allowed shareholders to realize more than 90% appreciation in their shares' value since the April 2012 lows in natural gas prices, and we believe it will help Peyto consistently generate long-term economic profits.

Canadian Pacific Railway (CP) CEO Hunter Harrison is the second finalist in our CEO of the Year award. Harrison, who has now successfully transformed three railroads in his career, joined CP in June 2012 and dramatically improved the company's operations by making rapid changes to senior leadership, assets, and operating practices. According to Morningstar industrials analyst Keith Schoonmaker as a result of Harrison's actions, "CP is now on track for nearly 30% operating margin in 2013 (up from 18.7% in 2011), and we project that returns on invested capital will improve from 2% in 2011-12 to 14% in the next few years, easily exceeding the firm's cost of capital."

Our final CEO of the Year award candidate is Gilead Sciences(GILD) CEO John Martin, who has led the company since 1996 and has overseen tremendous growth during his tenure. Much of Gilead's success is attributable to a strong acquisition strategy under Martin's watch that vaulted the company into leading positions in the antifungal, HIV, and hepatitis C markets. Morningstar health-care analyst Karen Andersen expects Gilead's returns on invested capital to return to the mid-20% range by 2017 and believes that Gilead's patent protection on key drugs makes "visibility on profits clearer at Gilead than at many of its large-cap biotech peers."

If you have any questions about our CEO of the Year award or Morningstar's stewardship methodology, please post them in the comments section below.

Morningstar will announce its 2013 CEO of the Year in January 2014. For the complete list of past winners, visit http://corporate.morningstar.com/CEOhalloffame.

Morningstar introduced its CEO of the Year award in January 2000. Winners are chosen by senior members of Morningstar’s equity analyst team based on their in-depth independent research.