7 Stock Picks to Beat the Market in 2016

We got some help from Morningstar, whose calls don't draw a lot of attention—but do outperform.

Even after the sharp sell-off that kicked off the new year, the stock market isn’t bargain-priced. The good news: Stocks are cheaper than they were on New Year’s Eve—making this a good time to beef up your investments in solid companies like the ones I recommend below. These seven picks, in my view, will beat the market—whether the sell-off accelerates or ends today.

I have a lot of confidence in my fund picks. But when I’m hunting for stocks, I often turn to Morningstar. Morningstar is far better known for its fund coverage, but it employs more than 100 stock analysts. More important: The track record of Morningstar’s stock picks is superb.

Over the past 10 years, the recommendations of Morningstar Stock Investor, which draws on the work of the firm’s analysts, returned an annualized 9.6%—an average of 2.3 percentage points per year better than Standard & Poor’s 500-stock index. (The figures are through December 31, the last date for which returns for the newsletter are available.) What’s more, the clearly written newsletter, which costs $125 a year, doesn’t have a huge audience. Unlike what happens when a big brokerage makes a call, the price of a stock rarely pops or drops dramatically when Morningstar makes a buy or sell recommendation.

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Editor Matt Coffina, like most market analysts, sees stocks as close to fully valued. But below are his best picks for 2016. Returns, prices and related data are as of January 14.

Berkshire Hathaway Class B (symbol BRK.B $128.07). Warren Buffett, who painstakingly assembled this sprawling conglomerate, with annual sales of about $212 billion, over the past half-century, is 85 years old and irreplaceable. But he’s done as much as any CEO could to prepare the firm for his successors, including delegating most of the stock picking to two much younger men. Berkshire lost 15% over the past year, setting up an attractive buying opportunity. The stock trades at 1.2 times book value (assets minus liabilities). In Buffett’s view, Berkshire is undervalued when it trades at 1.2 times book value, and he will buy back shares when its valuation falls to that level or below. That effectively sets a floor under the stock’s price unless, of course, book value falls.

Cooper Companies (COO $124.04) is the third largest manufacturer of contact lenses in a business that four global companies dominate. It stands to benefit from the growing number of people in emerging markets who are getting contacts and the shift in developed nations to more expensive lenses that are disposed of daily. Coffina says Cooper should generate double-digit-percentage annual earnings growth over the next five years. The stock trades at 16 times estimated 2016 earnings, a bit more than the price-earnings ratio of Standard & Poor’s 500-stock index.

Another defensive pick is Express Scripts Holding (ESRX $77.51), the largest U.S. pharmacy benefit manager, with more than 1.3 billion claims processed in 2014. It contracts with major insurance companies and employers to provide prescription medications. Its size in this fast-growing industry gives it unrivaled power to negotiate prices with drug companies. Its growing mail-order business, which supplies prescription drugs directly to consumers, boasts especially healthy profit margins. The stock, at 13 times estimated 2016 earnings, looks like a good deal.

Looking for a bargain in the battered oil patch? Magellan Midstream Partners LP (MMP $66.19) could be your ticket. Many oil-and-gas master limited partnerships took on too much debt and pledged to pay high payouts to investors, who took a beating for those excesses last year, when energy prices cratered and the biggest MLP, Kinder Morgan (KMI $13.98), slashed its dividend by 75%. Magellan sank with other MLPs, losing 8% over the past 12 months (the figure includes Magellan’s payouts). But Magellan is in glowing financial health compared with most of its competitors, Coffina says, and it should be able to generate high-single-digit percentage annual profit growth over the next five years. Moreover, Magellan is somewhat insulated from drops in energy prices. About 85% of its revenue comes from charging fees for the transportation and storage of oil and gas in the central and eastern U.S. The MLP yields 4.6%, and Magellan’s distribution looks secure. One negative: As with all MLPs, the payouts you’ll collect from Magellan can complicate tax preparation.

Health care stocks in the S&P 500 gained 7% last year, handily beating the S&P 500’s 1.4% return. Health care continues to be my favorite sector. Unlike some big drug makers, Switzerland-based Novartis (NVS $82.70) has remained innovative, and most of its patent losses are behind it. It has a large a pipeline of potentially important drugs in development, including treatments for heart failure and cancer. Novartis’s American depositary receipts trades at 16 times forecasted 2016 profits, a bargain if even only a couple of those development-stage chemicals become blockbuster drugs.

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Online travel agency Priceline Group (PCLN $1,121.38) makes just 12% of its bookings in the U.S. But it’s a huge player overseas, thanks partly to its 2005 acquisition of Booking.com. In the U.S., chains are increasingly driving business to their own Web sites. In Europe, where Priceline gets 55% of its bookings, chain hotels aren’t nearly as big as they are in the U.S. Independent boutique hotels are less likely to cut their ties with Priceline, which typically takes a 15% cut of revenue for online bookings. Priceline has been hurt by the strong dollar. It trades at a reasonable 16 times 2016 earnings estimates.

Ventas (VTR $54.64) is a real estate investment trust that owns 1,600 senior-living communities, assisted-living and skilled-nursing facilities, and other medical buildings in the U.S. and Canada. It rents out most of its facilities, but derives about one-third of its revenues from facilities it operates itself. Most of the occupants of all of these facilities are relatively affluent patients with private insurance, meaning Ventas has little exposure to the vagaries of Medicare and Medicaid funding. Coffina says that the high quality of the REIT’s properties will also protect Ventas from overbuilding in senior housing. The stock yields 5.3%, and Ventas has boosted its dividend at an annual rate of 6.4% over the past five years.

See my Other Picks: The 7 Best Bond Funds for 2016 and: The 7 Best ETFs for 2016

Steve Goldberg is an investment adviser in the Washington, D.C., area. He, one or more clients, or both own all these stocks except for Cooper and Ventas.

Steven Goldberg
Contributing Columnist, Kiplinger.com
Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.