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5 Stock Picks from Morningstar

Morningstar is known for its expertise in tracking mutual funds. But the firm does at least as well picking stocks.

When you think of Morningstar, you think of mutual funds. The Chicago-based research firm does a solid job researching funds, and it probably offers more insights into more funds than anyone else. But for stocks, most people look elsewhere.

Big mistake. Morningstar employs about 100 stock analysts, and all told they cover almost 2,000 companies. By contrast, the firm employs about 90 analysts to cover mutual funds and exchange-traded funds.

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And the Morningstar StockInvestor newsletter has a first-rate record of picking stocks. From the inception of its “Hare” and “Tortoise” portfolios on July 31, 2001, through the end of September, the portfolios returned an annualized 5.6% and 5.3%, respectively, according to the authoritative Hulbert Financial Digest. That compares with an annualized gain of 2.4% for the Wilshire 5000 Total Market index, which essentially covers the entire U.S. stock market.

Morningstar’s analysts rate stocks from one star, the lowest rating, to five stars, the highest. But unlike the firm’s fund ratings, which are based entirely on statistical measures, Morningstar analysts also consider subjective factors in determining a stock’s star rating. At times, such as when the market was bottoming in March 2009 following a vicious, 18-month-long selloff, Morningstar gave five-star ratings to close to half the stocks it followed. Today, with the market up 84% from its low, fewer than 50 stocks earn five stars.

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Paul Larson, 39, edits Morningstar StockInvestor. He selects the stocks that make up the two portfolios. Larson mainly focuses on “wide-moat” companies (those with sustainable competitive advantages), and he picks them when they’re selling at bargain prices (put a wide-moat company together with a bargain share price and the result is often a five-star rating). He generally keeps a stock in a portfolio until its rating falls to three stars or lower. That leads to an average holding period of just over four years.

Here’s what Morningstar’s analysts and Larson like now:

International Speedway Corp. A (symbol ISCA) owns or operates 13 of America’s most popular auto-racing tracks, including Daytona and Talladega. The company hosts more than 100 races per year, bringing in revenue from ticket sales, broadcasting rights, concessions and sponsorships. Fans are loyal, creating a barrier to entry for competitors. At $23.70, the stock trades at 15 times average analyst earnings estimates for the next 12 months (all prices and related figures are as of the November 22 close).

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Lowe’s Companies (LOW) is the world’s second-largest home-improvement retailer, with 1,700 stores in North America and annual revenues of $47 billion. Its huge size allows Lowe’s (and its larger rival, Home Depot) to demand low prices from suppliers and save money at virtually every step along the supply chain. That means Lowe’s should continue to grow in a segment of the retailing industry that remains highly fragmented. The stock, at $22.33, trades at 14 times estimated earnings for the next 12 months.

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Pfizer (PFE) is losing patent protection next year on Lipitor, its cholesterol-lowering blockbuster drug. But its recent takeover of Wyeth and new drugs emerging from its own labs should help it replace the loss of Lipitor and other big-selling medicines. Although health-care reform will likely limit profits per pill, Pfizer will benefit from the addition of tens of millions of newly insured Americans. Larson says Pfizer and other health-care stocks are cheap. At $16.63, Pfizer trades at just seven times estimated earnings for the next 12 months and yields a hefty 4.3%.

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St. Joe (JOE), the largest private landholder in Florida, has come under attack from David Einhorn, of hedge fund Greenlight Capital, who has shorted the stock (bet on it to fall). But Morningstar analysts recently visited some of St. Joe’s properties and came to the conclusion that the stock is undervalued, not overvalued, as Einhorn argues. St. Joe holds property worth roughly $6,000 an acre, the analysts concluded. But with the stock at $17.53, the market is valuing St. Joe’s holdings as if they are worth only about $2,600 an acre. Meanwhile, St. Joe continues to develop its holdings in Florida’s panhandle. The company boasts a solid balance sheet, with $200 million in cash and just $40 million in debt. St. Joe is expected to lose money in the coming year because of the amount it’s spending to develop its properties.

Western Union (WU) isn’t about sending telegrams anymore; it’s about sending money. Through a global network of more than 400,000 outside agents, it’s the largest money-transfer company in the world. Western Union has been pushing prices down in an effort to drive smaller competitors out of the market. The number of Western Union money transfers has been growing at about 8% annually. The stock, at $18.22, trades at 12.5 estimated earnings for the coming 12 months.

Larson tries to diversify his picks by industry. But two sectors you won’t find on StockInvestor’s recommended list are media and telecommunications. Both, he says, are being crippled by rapid changes in technology. Telecom faces competition from cable companies, and media-content providers compete with one another in an increasingly fragmented market. The more channels there are delivering news, entertainment and the like, the fewer opportunities for turning a profit.

A monthly subscription to the print version of StockInvestor costs $125 annually; a subscription to the electronic version is $115 a year. Both subscriptions include access to msi.morningstar.com, which contains updates on suggested portfolio trades. Most investment newsletters are filled with hot air. This one boasts solid advice.

Steven T. Goldberg (bio) is an investment adviser.

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