When I look for good stocks, I often turn to Morningstar. Although it’s much better known for its mutual fund research, the Chicago-based firm boasts a superb record with its stock selections. What’s more, few institutional investors seem to pay attention to Morningstar’s stock picks. That means the stocks don’t pop in price when Morningstar’s analysts (more than 100 strong) recommend them—or tank when they say “sell.”
But first, permit me a one-paragraph digression. Forget politics. Forget Donald Trump. If you want to be a successful stock picker, focus on finding reasonably valued companies with sustainable competitive advantages over their rivals. If the stocks face temporary political headwinds, so much the better—you’ll be able to snap them up at bargain prices. Remember: Patience is essential for successful investing.
Below are seven exceptional companies that I’ve gleaned from the recommended list of the Morningstar Stock Investor newsletter (opens in new tab). Share prices are as of December 6. Price-earnings ratios are based on the average of analysts’ estimates compiled by Zacks Investment Research.
It’s a bullish sign whenever a company’s chief product enters common parlance. “Google it” has become the ubiquitous answer to almost every question. Alphabet (symbol GOOGL (opens in new tab), $776.18), the name of Google’s parent company since mid 2015, dominates global search, with 80% of all queries. The more people who search, the more data Alphabet acquires and the more companies are drawn to advertise on various Google platforms. This virtuous circle shows no signs of slowing. In addition, Alphabet owns Android smartphone software, Google maps, Gmail and YouTube, among other services. The company also invests in futuristic products, such as self-driving-car technology. The stock’s P/E is 25 based on analysts’ estimates for the next 12 months. That’s well above the P/E of 17 for Standard & Poor’s 500-stock index but a reasonable valuation for such an extraordinary company.
I’m tired of investors who worry about what will happen to Berkshire Hathaway (BRK.B (opens in new tab), $161.34) when Warren Buffett is no longer at the helm. At 86, Buffett shows few signs of slowing down. What’s more, he has put together a solid team that will take over the conglomerate’s far-flung operations when he’s gone. Buffett’s successors are already doing much of the work to keep Berkshire going. No, they’re not as brilliant as Buffett, but they don’t have to be. The Oracle of Omaha has assembled a wonderful collection of businesses that’s still dominated by insurance but that includes more than 70 other units, ranging from BNSF Railway to Fruit of the Loom clothing. Berkshire, which generates annual revenues of $218 billion, is not a hot stock, but the company will likely continue to grow steadily. The stock currently trades at 1.5 times book value (assets minus liabilities), Buffett’s preferred way of measuring the company. By that measure, the shares are not cheap. But Morningstar analyst Greggory Warren predicts that Berkshire’s book value will expand by a high-single-digit to low-double-digit percentage rate over the next few years. Nothing shabby about that kind of growth. Berkshire, incidentally, is one of three stocks that I recommended for 2016 and I am recommending again now.
Every so often a company comes along with such a good idea that it establishes a secure market niche you never knew existed. Consider CarMax (KMX (opens in new tab), $60.50), which has brought transparency and customer-friendly sales practices to the benighted used-car industry. With CarMax’s no-haggling model, the salesperson earns the same commission regardless of which car you buy, and the same salesperson works with you on financing, so you’re not passed from person to person at the car lot. Behind the scenes, CarMax boasts superior data on car pricing that enables it to buy used cars at attractive prices. CarMax dominates its space; no other firm that offers no-haggle pricing is anywhere near as large. Finally, the stock trades at a reasonable 17 times estimated year-ahead earnings.
Bigger is sometimes better. Express Scripts (ESRX (opens in new tab), $76.73), which I also recommended for 2016, processes roughly 1.3 billion prescriptions annually, making it the nation’s biggest pharmacy-benefits manager. The company purchases medications from pharmaceutical firms and distributes them to individuals covered by thousands of insurance companies, managed-care organizations and employers. Its size allows it to negotiate better prices from drug makers. Size also helps the firm increase its profit margins through operating efficiencies. Express Scripts is in a legal tussle with Anthem (ANTM (opens in new tab)), a health care insurer that has accused Express Scripts of overcharging for drugs. But any adverse court developments are more than fully reflected in Express Scripts’ shares, which trade at just 11 times estimated year-ahead earnings.
Wall Street has fallen out of love with Facebook (FB (opens in new tab), $117.31), pushing its price down 16% since late October. Rising interest rates altered assumptions used by stock analysts in valuing companies—and those trading at relatively high valuations tended to get marked down the most. But what’s not to like about Facebook? Instead of turning out to be a one-trick pony, Facebook keeps coming up with new products and services that increase the amount of time users spend on its sites, thus increasing ad revenues. Facebook also keeps getting better at helping advertisers target the users they want. The Facebook app, Instagram, WhatsApp and Messenger are among the most popular applications on mobile devices as well as computers.
Although Facebook’s meteoric growth is bound to slow, revenues and profits continue to expand rapidly, suggesting that the stock, at a seemingly high 28 times year-ahead earnings estimates, is reasonably priced.
Health care is my favorite sector. New drugs are coming to market at a rapid clip, and demand for better health care is increasing both among aging baby boomers and a growing middle class in emerging nations. Yet investors have punished many health care stocks because of concerns that Obamacare may be repealed, leading to less demand for prescription medicines.
Case in point: Novartis AG (NVS (opens in new tab), $68.96), which I recommended for 2016 and continue to favor. The American depositary receipts of the Swiss-based drug giant have fallen 19% since late July. True, Novartis lost patent protection this year on two blockbuster products: Diovan, a cardiovascular drug, and Gleevec, a cancer medication. But Novartis has a large pipeline of promising new drugs in clinical trials, as well as several current blockbusters, including Gilenya, for the treatment of multiple sclerosis, and Afinitor and Tasigna for leukemia. Trading at just 14 times 2017 earnings, Novartis is attractive.
Visa (V (opens in new tab), $77.11) is one of a handful of companies that are profiting from the migration from cash to plastic all over the world. Visa accounts for roughly half of all credit card transactions and three-quarters of debit card transactions, earning a small percentage from merchants every time you use your Visa card. The stock, trading at 24 times year-ahead earnings estimates, is hardly undiscovered. New technologies are biting off some of plastic’s market share, and large merchants are negotiating to reduce Visa’s fees. But Morningstar analyst Jim Sinegal says Visa’s strong competitive position will remain intact.
For those of you wondering how my picks for 2016 did, they were okay but not great. From the date we priced the stocks in mid-January through December 5, my choices returned an average of 14%, including dividends. That lagged the S&P 500 by three percentage points. My best picks were Priceline Group (PCLN (opens in new tab)) and the Cooper Companies (COO (opens in new tab)), which gained 34% and 32%, respectively. Hurt by the woes of the health care sector, my worst choices were Novartis and Express Scripts, which lost 13% and 1%, respectively
Steve Goldberg (opens in new tab) is an investment adviser in the Washington, D.C., area. He and some of his clients own shares of all the stocks in this article.
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