Morningstar Advisor - August/September 2009 - 65

research from Roger Ibbotson and others, is that investors have tended to be paid handsomely for putting up with this illiquidity. (See “The Liquidity Premium” in the June/July issue.) streams than larger companies—financial health is crucial to viability. Here are four stocks that made the cut in June. Actuant ATU And Revenue TTM < $2,000 We’re putting a revenue screen here in order to focus on small companies. The small-cap universe consists of two types of firms: small companies and fallen angels (formerly large firms that collapsed in market value). While the latter category provides interesting investing opportunities at times, it’s also not for the faint of heart, particularly in the midst of a once-in-a-generation financial crisis. Actuant is composed of seemingly unrelated businesses that are glued together with deep distribution networks and a strong Asian sourcing group. These strategic assets give Actuant the ability to develop and deliver its products at a lower cost than others in the industry. Coupling this cost advantage with broad diversification across customers, product lines, and geographies has allowed Actuant to grow profitably in the face of competition and market cyclicality. A key part of Actuant’s growth strategy has been acquiring smaller companies that can be easily deployed to supplement its core industrial business. ATMI ATMI reports. When an individual applies for a loan, the lender will pull a report from one or all of the credit bureaus–Equifax EFX, Experian EXPGY, and TransUnion. Fair Isaac’s algorithm is applied to the consumer’s credit data to generate the FICO score. This method of scoring has become so entrenched at banks and other loan agencies that switching to a new scoring method would require a significant amount of time and money to retrain loan officers and modify systems. Lenders have little reason to switch away from the FICO score as no other product has proved as reliable. Also, FICO scoring represents a small sliver in the very large financial-services pie, creating little economic incentive for users to switch scoring methods. These factors combine to make FICO scoring extremely profitable for Fair Isaac. Operating margins in this segment usually hover around 60%. International Speedway ISCA And Economic Moat 5 None In times of economic duress—and particularly when inflation threatens—it’s important to focus on companies with economic moats. These tend to be firms with some pricing power and that can raise their own selling prices in line with input costs. The resulting universe has an average market cap of $800 million and an average daily trading volume of 714,500 shares. And Morningstar Rating for Stocks 5 QQQQQ Naturally, we focus on stocks that currently have 5-star Morningstar Ratings. This means they trade at enough of a discount to our estimated fair values to warrant our strongest buy recommendation. And Morningstar Financial Health Grade <C We also require an arm’s length distance from financial distress, which Morningstar’s Financial Health Grade is designed to estimate. Particularly among small companies— which tend to have less-diversified revenue ATMI is a top supplier of materials used during chip fabrication. The firm will benefit from continued advances in semiconductor technologies, but it is presently mired in a severe cyclical downturn in business conditions. Demand is driven by the number of wafer starts (the number of silicon wafers placed into production) in the semiconductor industry, as ATMI’s materials (such as gases, liquids, and various chemicals) are consumed during manufacturing. Therefore, ATMI’s business is much steadier than those of chip equipment suppliers, which depend on chipmakers’ volatile capital spending. Since the firm disposed of the last of its noncore chip equipment business in 2004 and focused solely on consumables, profitability has improved substantially. Moreover, because the material business is not particularly capitalintensive and operating margins of 20%-plus are achievable, we think ATMI’s returns on invested capital can increase to the upper teens in the long run. Fair Isaac FIC International Speedway benefits from barriers to entry that prevent other track operators from competing in its markets, as well as substantial intangible assets that keep fans loyal to its tracks. These competitive advantages give the firm a wide economic moat. Nascar, like most sports, has strong traditions. Fans and drivers are accustomed to having certain races at certain tracks on certain dates, and any change would probably result in significant backlash. This provides a reliable revenue stream for International Speedway, as it can count on Nascar to distribute races in a predictable way each year. Because fans’ loyalty to tracks is so strong, it would be extremely difficult for any competitor to enter a region with an existing track and usurp its races—just as it would be difficult for Wrigley Field to lose the Cubs to a newly built ballpark in Chicago. Haywood Kelly, CFA, is vice president of equity research at Morningstar. Fair Isaac developed and maintains the FICO score that accompanies all consumer credit MorningstarAdvisor.com 65

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Morningstar Advisor - August/September 2009

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