Morningstar Advisor - Summer 2007 - 61

an entrenched competitive advantage that’s likely to sustain their profits well into the future. In Morningstar’s parlance, these stocks possess wide or narrow economic moats. and Economic Moat None Finally, desirable as a sustainable income stream might appear, we also want to ensure that we reap a total return that’s commensurate with the risk of the investment we’re making. With that in mind, we should try to buy stocks at a reasonable price. While this might seem like a task easier said than done, we can again tap the collective know-how of Morningstar’s stock analysts, whose stock starratings are based on a comparison of a stock’s price to the analyst’s estimate of a its intrinsic worth. The cheaper a stock on that basis, the more stars it garners. Thus, by sticking to stocks that are rated 3 stars or higher, we can better ensure that we don’t pay a king’s ransom for an outsized dividend stream. and Morningstar Rating Overall 3 procure handsets and equipment at advantageous prices. Vodafone can also leverage its expansive footprint by developing a product in one country and then rolling out to many others at nominal incremental expense. In addition, Vodafone owns a minority stake in Verizon Wireless, in our opinion the best-run wireless company in the U.S. Management has divested underperforming units and redoubled its effort to allocate capital more efficiently. Linear Technology LLTC Analog chip design expertise and processing technologies coupled with flawless execution afford Linear Technology a wide economic moat. Linear has a grasp of premium power management circuits. It has focused on factory production since its early days. Linear differentiates itself from other semiconductor firms with its relentless focus on profitability. Management seeks to identify opportunities early on and be first to market with its proprietary products. Linear also derives a third of its revenue from the industrial sector, where lower individual order size and long product cycles give sellers a structural advantage. AstraZeneca AZN AstraZeneca, best known for its acid-reflux medicines, enjoys one of the most diversified drug portfolios in the industry. In addition to its gastrointestinal therapies, AstraZeneca boasts an impressive portfolio of drugs in oncology and cardiovascular and respiratory diseases. While AstraZeneca’s late-stage drug pipeline looks thin, the firm’s earlier-stage products hold promise. AstraZeneca’s returns on invested capital handily surpass its cost of capital, which is the hallmark of a widemoat business, and management is committed to returning excess cash to shareholders through dividends and share buybacks. Federated Investors FII Federated Investors, a diversified asset manager, has some of the most consistent profit margins in the industry. That trait is conferred largely by Federated’s foothold in the money-market fund business, where it claims a 7% market share. Though we’re not optimistic about Federated’s equity fund business, which teems with inconsistent or downright lousy performers, we’ve been encouraged by Federated’s recent efforts to improve that area. Challenges notwithstanding, Federated’s plump profit margins, strong returns on invested capital, and prodigious free cash-flow generation earn the firm a wide economic moat. Getty Realty GTY Getty excels at creating wealth for shareholders. Though the firm acquires properties infrequently, management has made those purchases count by buying quality gas stations and convenience stores on the cheap. Getty’s returns on invested capital are among the highest of the 70-plus REITs that we cover. However, Getty rents almost exclusively to one tenant, which greatly raises its risk profile. Thus, investors should demand a large margin of safety before investing in Getty. Pfizer PFE Drug-maker Pfizer’s strong research and development, marketing efforts, and broad portfolio of patent-protected drugs fortify the wide moat around the firm’s pharmaceutical business. With roughly 150 drugs in its pipeline, Pfizer stands an excellent chance of getting one or more of these drugs approved by regulators. Pfizer’s flush development pipeline should more than offset losses that Pfizer is likely to experience in the years ahead when a number of its blockbuster drugs go off-patent. K Our search yielded seven stocks on May 31. Johnson & Johnson JNJ Johnson & Johnson is No. 1 or No. 2 in medical devices, over-the-counter medicines, and several pharmaceutical markets. JNJ’s businesses are well positioned to benefit from demographic shifts, including the aging population in the U.S. and Europe and rising spending power in many developing countries. The company’s diverse revenue base has helped insulate it from the highs and lows that afflict its pharmaceutical competitors from time to time. The firm has reported more than 70 years of sales growth and churns out free cash flow reaching almost 20% of sales. This excellent cash generation has enabled the firm to grow its dividend for the past 44 years. Vodafone Group VOD The world’s biggest phone company by revenue, Vodafone enjoys impressive scale worldwide, especially in Europe, allowing it to Jeffrey Ptak, CPA, CFA, is a stock analyst with Morningstar. Share Your Best Ideas Send us a favorite stock screen that you use in your practice. We’ll consider printing it in this space for the benefit of other advisors. Submit it to magazine_editor@morningstar.com MorningstarAdvisor.com 61

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Morningstar Advisor - Summer 2007

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