Morningstar Advisor - February/March 2010 - 58

Investments à la Carte Four Picks for the Present Exchange-Traded Fund: Utilities Select Sector SPDR XLU $18K growth for the sector, but we are currently unsure if that trend will begin soon or a few years from now. Paul Justice Stock: Novartis NVS 12 S&P 500 TR $14K footprint in an area where pricing power is increasing with innovative vaccines and fewer competitors. Further, the company’s intentions to acquire a majority share of Alcon ACL should greatly boost its consumer business with additional sales from the fast-growing eye-care business. Haywood Kelly Mutual Fund: Sequoia SEQUX $14K 10 S&P 500 TR 14000 11000 09 8000 Bill Gross is tired of earning 0.1% on his money market funds, and you should be, too. In his December 2009 Investment Outlook, he stated his case for equitizing cash by buying utility stocks in today’s market environment. We agree, and we picked up a stake in the sector in our ETFInvestor newsletter’s portfolio at the end of October. Utilities Select Sector SPDR XLU provided the sector coverage we coveted at the lowest cost available on the market today, charging only 0.21% annually. With the S&P 500 dividend yield sitting at 2% and investment-grade corporate bonds yielding approximately 4%, utilities look extremely Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 appealing with their 4% to 6% dividend yields. Furthermore, utility dividend growth rates mean your incomeJul-06 Mar-07Nov-07 Jul-08 May-09Jan-10 Feb-05Oct-05Jun-06Feb-07Oct-07Jun-08 Apr-09Dec-09 Mar-05 Dec-05 steamApr-07 Feb-08Oct-08Jun-09 Apr-05 Feb-06Oct-06Jun-07 Mar-08 Dec-08 Sep-09 May-05 Apr-06Dec-06 Sep-07 grow at rates Jun-05 Jul-05 Aug-05 Aug-06 will likely Aug-08 Jul-09 Sep-05 Nov-05 Nov-06 Jul-07 Apr-08 May-08 Sep-08 Aug-09 Nov-08 Oct-09 Nov-09 May-06 than overall economic Sep-06 Aug-07 Dec-07 Feb-09 Mar-09 equal to Mar-06 or greater May-07 growth. Utilities participated fully in the market crash of 2008, but they did not participate in the rally of 2009, and we think that the industrials sector’s demand destruction is likely near its trough. Utilities have postponed several capital-intensive projects for a few years given the sudden excess capacity in electricity generation that is now available, which means that any incremental demand increases will translate into high cash flows over the next few years. Sometime over the next decade, North American utilities will be forced to make substantial investments. The United States is plagued by aging, fragmented, and capacityconstrained infrastructure. This should eventually lead to considerable earnings 11 S&P 500 TR In an industry plagued by stagnant growth, Novartis emerges as a juggernaut 5000 with diversified operating platforms and an industry-leading number of new potential blockbuster drugs. Strong intellectual property supporting multibillion-dollar products combined with a plethora of late pipeline products create a wide economic moat for the firm. Further, with the patent losses of hypertension drug Lotrel, fungal medicine Lamisil, and epilepsy treatment Trileptal in the rearview mirror, the company is poised for robust near-term growth. Novartis derives its strength from a diversified Jan-06 Jan-07 Jan-08 Jan-09 operating platform that includes branded pharmaceuticals, Feb-07Aug-07Feb-08Aug-08Feb-09Aug-09 Feb-05 Sep-05Mar-06 Oct-06Apr-07 Mar-05 Apr-05 May-05 Feb-06Aug-06generics, vaccines, Mar-09Sep-09 Jun-05 Jul-05 Apr-06 May-06 Mar-07Sep-07 Apr-08Oct-08Apr-09Oct-09 Jun-06 Jul-06 May-07 Jun-07 Jul-07 May-08 Dec-08Jun-09Dec-09 Jun-08 diagnosJul-08 Sep-08 May-09 Jan-10 Nov-08 Jul-09 Nov-09 Aug-05 Oct-05 Nov-05 Sep-06 Dec-05 Nov-06 Dec-06 Oct-07 Nov-07 Dec-07 Mar-08 tics, and consumer products. Although the majority of Novartis’ competitors focus solely on the high-margin branded pharmaceutical segment, Novartis runs four complementary operations that reduce overall volatility and create cross-segment synergies. For example, not only does its generic business, Sandoz, serve to grab a portion of the billions of dollars in competitive branded products losing patent protection during the next 10 years, but it also extends the lifecycle of in-house products as patents expire. Also, the vaccine division (largely created by the 2006 acquisition of Chiron) offers the company a substantial Jan-05 The story at Sequoia is as straightforward as they come. The fund has posted great risk-adjusted returns since its 1970 inception by steadfastly applying the same Buffettinspired strategy. Bob Goldfarb has been on the fund since 1971, and he and David Poppe lead a team focused on high-quality firms with enduring competitive advantages and strong finances. Nearly all the portfolio’s firms have earned economic moats from Morningstar’s equity analysts and half have wide moats, indicating they’re the steadiest, most defenJan-05 Jan-06 Jan-07 Jan-08 Jan-09 sible businesses. In contrast, just 20% of the S&P 500 Index’s names have wide moats and Feb-05Oct-05Jun-06 moats. AndJun-08 May-09Jan-10 Mar-05 Dec-05 Sep-06 Jun-07 May-08 Apr-05 a third lack May-07 May-05 Apr-06Dec-06 Sep-07 Jul-08 Jun-09 Jun-05 May-06 Jul-05 Aug-05 Jul-06 Sep-05 Aug-06 Aug-07 Aug-08 Jul-09 Nov-05 Nov-06 Oct-07 Sep-08 Aug-09 Nov-07 Oct-08 Sep-09 Dec-07 Nov-08 Oct-09 Nov-09 Dec-09 nearly Feb-06Oct-06 Jul-07 this portfolio’s Mar-06 Feb-07 Mar-07 Feb-08 Dec-08 Apr-07 Mar-08 Feb-09 Apr-08 Mar-09 Apr-09 debt/capital ratio has always been much lower than the benchmark’s. Sequoia’s collection of topnotch, low-debt firms behaves exactly as expected. It performs well in most up markets and holds up much better than most in big downdrafts. It puts up solid absolute gains but lags racier rivals in years where speculative fare does best, such as 2003 and 2009, when the fund was up nearly 20% but lagged most of its peers. But as 2008’s downdraft showed: The time to buy the insurance a quality portfolio provides is before you need it. Michael Breen 58 Morningstar Advisor February/March 2010
Morningstar Advisor - February/March 2010

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