Morningstar Advisor - August/September 2011 - (Page 68)

Screens Cheap, Local, and On a Roll By Timothy Strauts Use this screen to find undervalued U.S. ETFs with momentum. The U.S. stock market has been on a great run over the past two years. Since the March 2009 low, the S&P 500 is up just more than 100%. If your clients have been fully invested these past two years, they should be pretty happy, but there are many investors who still have cash on the sidelines. For those investors looking to put money to work, where should they invest today? Security Type And 5 ETF Morningstar Category 5 Domestic Stock For this screen, we will focus on the domesticstock exchange-traded fund universe. To find areas of the market that are still undervalued, we will lean on Morningstar’s equity analysts for guidance. The average star rating for an ETF’s holding is an assetweighted average of the Morningstar Rating for stocks in the portfolio. This average star rating offers the insight into the valuation of the equity holdings in a portfolio and draws on the research of Morningstar’s stable of in-house equity analysts. Many people are familiar with the ETF and mutual fund star rating methodology, which ranks funds based on risk-adjusted returns for three-, five-, and 10-year time periods. So an ETF’s star rating is a backward-looking measure. A stock’s star rating, however, is forward-looking. The Morningstar Rating for stocks has nothing to do with the stock’s historical performance and is calculated by comparing a stock’s current market price with Morningstar’s estimate of the stock’s fair value. The rating system also includes a risk adjustment, so it’s more difficult for a company with above-average business risk to earn a 5-star rating. The margin of safety our analysts demand before giving a stock 5 stars is determined by their assessment of business risk. Our analysts assign stocks to one of three business-risk ratings. Each of the five star-rating levels is defined based on expected returns, which assume that the stock’s market price and our fair value estimate for the stock eventually converge. Under the system, 3-star stocks are those that should offer a “fair return,” one that compensates for the risk of the stock, or a rate of return that’s comparable to the stock’s cost of equity. (The cost of equity is often called a “required return” because it represents the And Holding Avg Star Rating . 3.30 68 Morningstar Advisor August/September 2011

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2011

Morningstar Advisor - August/September 2011
Letter From the Editor
Simplicity and Design Matter
Do You Use ETFs Strategically or Tactically?
The Institutional Way
How to Analyze an ETF
Eyeing ETFs’ Next Chapter
Small-Cap/Large-Cap Flip-Flop?
Four Picks for the Present
Investment Briefs
Morningstar Investment Conference
Pitfalls of Peer Groups
A REIT Recovery, With a Catch
Turning Fund Distribution on Its Head
Here Come ETF Managed Portfolios
Circle These Picks Amid the Crop of New ETFs
ETF Analyst Favorites
Beware, the Accidental Portfolio Manager
It’s the Destination, Not the Vehicle
New Growth, Rooted in Experience
Better Ways to Look at ETFs
How to Better Manage Your Clients’ Future(s)
More Bargain Than Bubble
Cheap, Local, and On a Roll
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
First-Quarter Assets Hit an All-Time High
You Say You Want a Revolution?

Morningstar Advisor - August/September 2011