Morningstar Advisor - Spring 2008 - (Page 19) but the firm’s decision in recent years to hire subadvisors for some of its struggling funds, replacing in-house managers, should be applauded. The firm has done an impressive job in choosing subadvisors, including Wellington Management and PIMCO. Market Outlook: Best Valuations since 2002 If you compare stock prices to underlying business value, stocks were cheaper at the end of March than at any time since 2002, says Haywood Kelly, Morningstar’s director of security analysis. Kelly based his view on the fair value estimates Morningstar stock analysts place on approximately 2,000 stocks. Since Morningstar began rating stocks, the cheapest the market looked was in October 2002, when the median price/fair value ratio of Morningstar’s coverage universe was 0.78. (A price/fair value estimate ratio below 1.0 is undervalued.) In March, the market came within shouting distance of that figure, hitting 0.83. Even after a rebound in the market later that month, the ratio went back up to just 0.88, meaning that the median stock Morningstar covers is 12% undervalued. (To see the most up-to-date market valuation graph, go to: http://www. morningstar.com.) Kelly says that each of Morningstar’s 12 sectors appeared undervalued on a median basis in March. Each sector was cheaper as measured by median price/fair value ratios than it was three months prior. Some of the pricey sectors at the end of 2007—telecom, health care, utilities—had fallen the sharpest in 2008. American Funds Contrarian as Usual Mutual fund analyst Greg Carlson, who is editor of Morningstar’s monthly newsletter American Fund Family Report, says that it’s noteworthy that American Funds managers have waded into the beaten-down financials sector. The funds aren’t known for diving into companies that carry a lot of downside risk. Thus, the managers apparently believe that most of the recent and future bad news is priced into the stocks, Carlson says. In December 2006, most of American’s equity portfolios held below-average stakes in financial stocks, Carlson says, because American’s managers thought margins and profits were at unsustainably high levels. But by December 2007, the managers had begun buying in the sector, as lenders and other financial firms had been hit hard by the implosion of subprime mortgages and the ensuing credit crunch. The funds’ stake, for example, in Citigroup C, which lost nearly half its value in 2007, jumped by one third during the year, as measured by the number of shares they hold. Their position in mortgage lender Fannie Mae FNM increased by 40%. The managers also dramatically increased their stakes in Bank of America BAC, and the funds bought modest positions in one of the most troubled names in the sector, mortgage lender Countrywide Financial CFC, which declined 78% in 2007. Not a single American Fund owned the stock at the end of 2006 (just before it hit the skids after a huge run). For Decade Ahead: Stocks (and an ETF) for 2018 Equity analyst Michael Coffina compiled a list of five stocks he says are well positioned to outperform in the coming decade. These firms share two key qualities, Coffina says. First, they possess either a wide or narrow moat that should remain intact—if not widen—through 2018. Second, negative news has driven their share prices into bargain territory. Each carries a 5-star rating as of March 31, meaning that their shares can be purchased for considerably less than where Morningstar analysts peg their intrinsic values. (Coffina owns shares in CX, AMGN, and WU.) McGraw-Hill Companies MHP Standard & Poor’s credit rating business took a hit in 2007, but Morningstar analysts think the company’s wide-moat business model remains intact. S&P shares a toll-collecting duopoly in credit rating with Moody’s and has significant international growth prospects. Cemex CX The weak U.S. housing market has been a drag on Cemex’s shares. But cement plants tend to operate as local monopolies, allowing Cemex to raise prices ahead of inflation. The company benefits globally from logistical efficiency and inland assets that face less competition. Amgen AMGN Despite safety concerns in 2007 over the company’s anemia drugs, Morningstar analysts think the company’s wide moat will persist through the next decade. Amgen Sector Valuation Changes Sector Current Median Price/ Fair Value Three Months Prior Change (%) Business Services Consumer Goods Consumer Services Energy Financial Services Hardware Health Care Industrial Materials Media Software Telecommunications Utilities Data as of March 14, 2008 0.88 0.89 0.78 0.93 0.88 0.85 0.90 0.90 0.91 0.88 0.90 0.93 0.97 0.94 0.84 0.94 0.92 0.93 1.00 1.00 0.92 0.96 1.00 0.98 –9.2 –5.3 –7.1 –1.1 –4.3 –8.6 –10.0 –10.0 –1.1 –8.3 –10.0 –5.1 MorningstarAdvisor.com 19 http://morningstar.com http://morningstar.com http://MorningstarAdvisor.com
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