Morningstar Advisor - Fall 2008 - 77

mining companies, small oil producers, and some luxury-goods companies. To isolate the smaller, high-growth firms with unique advantages not on their balance sheet, we will limit the screen to companies in the aggressive growth and speculative growth buckets. Monsanto MON And ( Type Or Type 5 Agressive Growth 5 SpeculativeGrowth ) Because we are searching for companies that derive most of their value from intangible assets rather than easily accounted for equipment and property, we have to be especially careful not to pay too much. To make sure that we can expect a solid return on our investment, we tap into the research of the Morningstar stock analysts and their estimates of the future cash flows for each of the companies. By narrowing our search to stocks with Morningstar Ratings of 4 stars or more, we will identify stocks that our analysts believe are undervalued. These stocks will be primed for higher growth and profits. Monsanto is, at its heart, a powerful R&D engine. The firm continues to plug an average of 10% of sales into its research efforts, but this belies the full scope of the firm’s R&D machine. As Monsanto has gained a larger share of the global seed market, more companies have sought to team up with the seeds giant to codevelop the next generation of seed technologies. Monsanto offers partners access to its best-in-class production and distribution capabilities, and this provides a crucial platform to leverage its plant technologies without the prohibitive expense of developing or purchasing its seed platforms. Collaborations will turbocharge Monsanto’s research engine. BioMarin Pharmaceutical BMRN costs, Fastenal will continue to steal market share from small, independent players. Corporate Executive Board EXBD Corporate Executive Board provides best practices research to approximately 4,700 corporate clients. The firm has built a large base of research and staff that would be very difficult for any new entrant to match quickly, and it benefits from a strong network effect. Having a large membership base means that the company has more empirical data on best practices and a larger peer network. This improves the quality of the company’s programs, which attracts more clients and widens the competitive advantage. Alnylam Pharmaceuticals ALNY And Morningstar Rating > 4 Stars Finally, given the current macroeconomic troubles and threat of recession, we want to avoid investing in the smallest companies. Small firms generally possess only inchoate intellectual property or competitive advantages, which can make the value of their intangible assets much harder to assess. Small companies are also the canaries in the economic coal mine, suffering the most during a recession because of their greater difficulty finding new capital. To reduce these risks, we will only consider companies with a market capitalization of $1 billion or more. BioMarin Pharmaceutical is a relatively young biotech specializing in treatments for rare diseases. It is amassing a portfolio of genetic disease therapeutics, and we think the firm’s profitable start to 2008 will be sustainable over the long run. BioMarin’s latest approval could be the most promising opportunity yet. Kuvan was recently approved to treat mild to moderate phenylketonuria, one of the most common metabolic disorders. Given Kuvan’s steep price, we think it has blockbuster potential. Fastenal FAST Alnylam is a pioneer in therapeutics based on RNA interference, a recently discovered mechanism that occurs naturally in cells and silences overexpressed genes, such as cancer-inducing or viral genes. Intellectual property will be critical in determining who profits from RNAi therapeutics, and while many patents are still being processed, Alnylam has a dominant position. Though it’s still in its early days, we think this company has a shot at becoming a leading biotechnology firm. Autodesk ADSK And Market Cap > 1,000.00 Our screen found six stocks on Aug. 22, 2008. As the name suggests, Fastenal focuses on fasteners—everything from nuts and bolts to screws and anchors. By offering more than 300,000 types of fasteners (and 380,000 maintenance, repair, and operations products) through its 2,000-plus stores, Fastenal provides far more selection and convenience than broad-line or regional distributors. Also, the company’s 12 North American distribution centers and in-house truck fleet provide a highly efficient path to market. Fastenal’s vast footprint of efficient stores is a salable attribute when pitching national and government accounts. As these customers consolidate vendors in search of lower Autodesk will continue dominating the market for computer-aided design software. Its products are the de facto standard in digital design. The firm benefits from its customers’ high switching costs: It takes time to learn a new design software application, and operational disruption and downtime costs discourage companies from changing providers. Substantial growth opportunities in emerging economies, new 3-D design products, and subscription fees for heavy users should help significantly increase revenues and profitability. Bradley Kay is an ETF analyst with Morningstar. MorningstarAdvisor.com 77

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Morningstar Advisor - Fall 2008

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