Morningstar Advisor - October/November 2010 - 41

My partner, Bob Rodriguez, and I used to joke about just opening up a restaurant. With me being Jewish and Bob being Mexican, we thought we’d just call it Casa Hadassah, home of the gefilte fish taco. You really had to consider your other alternatives at that point in time.
Steven Romick

comparison—much cheaper than they’ve ever been versus small caps. Let’s leave quality out of the equation for a moment. Let’s just start with large-cap stocks are much cheaper than small-cap stocks, as a relative statement. I agree with Ben that growth is very difficult to predict. I mean, it’s impossible to predict. But we believe that the larger-cap companies, on a relative basis, have better growth opportunities available to them than they have in the past, relative to small-cap companies, because we think that there’s more growth overseas than there is in the United States. Larger-cap companies, on average, have more overseas exposure. I believe that this begins to speak to the quality of larger-cap companies. I’m generalizing. There are many small-cap companies that do a lot of business overseas. But there are large-cap companies out there that get half their sales internationally. You’re less likely to find a lot of that in smaller companies.
Inker: We agree with an awful lot of that. I’m

to middle part of this decade, but now they’re expensive, and the big dopey blue chips are a lot cheaper.

Two Caveats: Margins and Interest Rates
Romick: The caveat, and I think this is

We do not know when, and we do not know how high. We would first need to know what kind of inflation we’ll have. Will rates increase with inflation or will there be relatively benign inflation but other exogenous variables that cause interest rates to increase? We would argue that rates are going to go up with or without inflation for a host of different reasons. If you get the higher interest rates without the kind of inflation that you can pass through in price increases, where your ability to get price is not keeping up with the rise in your input costs, then that’s going to negatively affect margins, so cash flow would also be negatively affected. We do raise the question that higher interest rates, in many cases, could create a lower P/E for companies. If you’re buying a company that historically looks cheap and it’s at 11 or 12 times earnings, that sounds great right now with interest rates where they are. But if the 10-year is at 7%, that might not look so great, unless otherwise justified by earnings growth.
Leggio: You pointedly said on your conference

not going to talk about the potential for large caps versus small caps to take advantage of growth outside of the United States, but as we see it, large caps look cheap relative to small all around the world. And when we look at quality, high quality looks cheap, but big high quality looks cheap relative to small high quality. And big value looks cheap relative to small value. And big growth looks cheap relative to small growth. That’s true not just in the United States, but globally. We have spent a lot of time overweight small caps. We loved them from the late 1990s to the early

problematic, is the question, what is the normal margin? Margins are still above average. A lot of these big companies have had a nice margin benefit from cost-savings programs, including firing people. Companies aren’t getting pilloried for it, because everybody knows how bad the economy is and that jobs are being lost right and left. There’s been a lot of fat cut out. So we question, what is the normal margin in these cases? Will Johnson & Johnson’s margin be as good as it’s been? They’ve optimized to a great degree. What is the sustainability of that margin? We’re an owner of Johnson & Johnson in a small way, but these are the questions that we’re asking ourselves, and it does raise some concerns. The other caveat with these large-cap companies—and this goes for stocks in general, for that matter—is that we look at some of these companies as infiniteduration bonds with rising coupons; they’re companies that we believe are going to be here a decade from now with higher earnings. When you think of it in those terms, you realize they’re going to be affected by a rise in interest rates. We think that a rise in interest rates is probable in the future.

call that cash may be an even better investment than some of these high-quality firms in a rising-interest-rate environment. Romick: If you’re smart enough to figure out when interest rates are rising and how much, then yeah. The question comes back to, what causes interest rates to rise? Is it inflation? If so, how much? And how is that company affected by it? We believe that some companies, like Aon Corp. AON, will benefit

MorningstarAdvisor.com 41


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Morningstar Advisor - October/November 2010

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2010

Morningstar Advisor - October/November 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What estate-planning strategies are you and your clients doing before the end of the year?
Next Steps for ETFs
Investment Briefs
Taking It Personal
A Model Practice
Find the Right Fit
Will REITs Put You in the Penthouse?
Prepare for the Worst
Tips for Common Family Situations
Might Makes Right
Built to Last
Four Picks for the Present
Tactical Strategies Miss Their Mark
Time to Hop on the Commodities Bandwagon?
Retailers Balance Caution and Catalysts
In Search of … Recession Survivors
Turmoil-Tested Small-Cap Funds
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Rise in Second Quarter
The Third Rail
Morningstar Advisor - October/November 2010 - Intro
Morningstar Advisor - October/November 2010 - Morningstar Advisor - October/November 2010
Morningstar Advisor - October/November 2010 - Cover2
Morningstar Advisor - October/November 2010 - 1
Morningstar Advisor - October/November 2010 - 2
Morningstar Advisor - October/November 2010 - Contents
Morningstar Advisor - October/November 2010 - 4
Morningstar Advisor - October/November 2010 - 5
Morningstar Advisor - October/November 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - October/November 2010 - 7
Morningstar Advisor - October/November 2010 - Contributors
Morningstar Advisor - October/November 2010 - Letter From the Editor
Morningstar Advisor - October/November 2010 - What estate-planning strategies are you and your clients doing before the end of the year?
Morningstar Advisor - October/November 2010 - 11
Morningstar Advisor - October/November 2010 - Next Steps for ETFs
Morningstar Advisor - October/November 2010 - 13
Morningstar Advisor - October/November 2010 - Investment Briefs
Morningstar Advisor - October/November 2010 - 15
Morningstar Advisor - October/November 2010 - 16
Morningstar Advisor - October/November 2010 - 17
Morningstar Advisor - October/November 2010 - Taking It Personal
Morningstar Advisor - October/November 2010 - 19
Morningstar Advisor - October/November 2010 - A Model Practice
Morningstar Advisor - October/November 2010 - 21
Morningstar Advisor - October/November 2010 - Find the Right Fit
Morningstar Advisor - October/November 2010 - 23
Morningstar Advisor - October/November 2010 - 24
Morningstar Advisor - October/November 2010 - 25
Morningstar Advisor - October/November 2010 - Will REITs Put You in the Penthouse?
Morningstar Advisor - October/November 2010 - 27
Morningstar Advisor - October/November 2010 - 28
Morningstar Advisor - October/November 2010 - 29
Morningstar Advisor - October/November 2010 - 30
Morningstar Advisor - October/November 2010 - 31
Morningstar Advisor - October/November 2010 - Prepare for the Worst
Morningstar Advisor - October/November 2010 - 33
Morningstar Advisor - October/November 2010 - 34
Morningstar Advisor - October/November 2010 - 35
Morningstar Advisor - October/November 2010 - Tips for Common Family Situations
Morningstar Advisor - October/November 2010 - 37
Morningstar Advisor - October/November 2010 - Might Makes Right
Morningstar Advisor - October/November 2010 - 39
Morningstar Advisor - October/November 2010 - 40
Morningstar Advisor - October/November 2010 - 41
Morningstar Advisor - October/November 2010 - 42
Morningstar Advisor - October/November 2010 - 43
Morningstar Advisor - October/November 2010 - 44
Morningstar Advisor - October/November 2010 - 45
Morningstar Advisor - October/November 2010 - Built to Last
Morningstar Advisor - October/November 2010 - 47
Morningstar Advisor - October/November 2010 - 48
Morningstar Advisor - October/November 2010 - 49
Morningstar Advisor - October/November 2010 - Four Picks for the Present
Morningstar Advisor - October/November 2010 - 51
Morningstar Advisor - October/November 2010 - Tactical Strategies Miss Their Mark
Morningstar Advisor - October/November 2010 - 53
Morningstar Advisor - October/November 2010 - 54
Morningstar Advisor - October/November 2010 - 55
Morningstar Advisor - October/November 2010 - 56
Morningstar Advisor - October/November 2010 - 57
Morningstar Advisor - October/November 2010 - Time to Hop on the Commodities Bandwagon?
Morningstar Advisor - October/November 2010 - 59
Morningstar Advisor - October/November 2010 - 60
Morningstar Advisor - October/November 2010 - Retailers Balance Caution and Catalysts
Morningstar Advisor - October/November 2010 - 62
Morningstar Advisor - October/November 2010 - 63
Morningstar Advisor - October/November 2010 - 64
Morningstar Advisor - October/November 2010 - 65
Morningstar Advisor - October/November 2010 - In Search of … Recession Survivors
Morningstar Advisor - October/November 2010 - 67
Morningstar Advisor - October/November 2010 - Turmoil-Tested Small-Cap Funds
Morningstar Advisor - October/November 2010 - 69
Morningstar Advisor - October/November 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - October/November 2010 - 71
Morningstar Advisor - October/November 2010 - 72
Morningstar Advisor - October/November 2010 - 73
Morningstar Advisor - October/November 2010 - 50 Most Popular ETFs
Morningstar Advisor - October/November 2010 - 75
Morningstar Advisor - October/November 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - October/November 2010 - 77
Morningstar Advisor - October/November 2010 - VA Sales Rise in Second Quarter
Morningstar Advisor - October/November 2010 - 79
Morningstar Advisor - October/November 2010 - The Third Rail
Morningstar Advisor - October/November 2010 - Cover3
Morningstar Advisor - October/November 2010 - Cover4
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