Morningstar Advisor - December 2013/January 2014 - (Page 70)

Screens Finding Value in a Pricey Sector By Dan Wood Financial services firms as a whole are trading at a premium after rebounding from their 2008 lows. A few bargains still persist, though. For many investors, the 2008 financial crisis is still fresh on their minds, which is a reason why they shy away from the financial services sector altogether-or at least its largest (and most controversial) members that foundered that year. Morningstar understands this hesitation. After all, the European sovereign debt crisis still persists and the U.S. economy has a long way to go to a full recovery. Despite that, financial stocks have performed well since the downturn and currently the sector trades at a 4% premium to Morningstar's estimate of fair value. (Tech is the most expensive at an 18% premium.) That doesn't mean there aren't some bargains left in the sector. Indeed, the recent rally hasn't lifted the share prices of every firm. There are still many large players that have cost advantages and attractive stock 70 Morningstar Advisor December/January 2014 prices. We searched for financial companies in Morningstar's coverage universe whose valuations reflected a discount to our assessment of their fair value. These firms also benefit from durable competitive advantages that can produce considerable returns for shareholders. Sector  Financial Services And ( Economic Moat  Narrow Or  Wide Economic Moat With competitive advantages in mind, we began our screen by looking for financial services stocks that Morningstar had assigned either a narrow or wide economic moat. Morningstar assigns a firm an economic moat rating based on two primary attributes. The ) first is whether a firm can generate returns in excess of its cost of capital. The rating also hinges on competitive advantages that prevent a company's returns from quickly eroding. Those advantages are usually earned through high switching costs, low operating costs that can't be equaled by rivals, intangible assets, a network effect, or efficient scale. These facets are exhibited in a variety of forms in the financials space. Firms such as J.P. Morgan JPM gain cost advantages through immense scale. On the other hand, insurance broker Marsh & McLennan MMC gains a competitive advantage from customizing solutions to specific risks for each client, which leads to high switching costs. Network effects are very powerful in the industry, too. A strong network depends on widespread acceptance and usage of a payment network. This generates a wide moat for firms such as Visa V.

Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014

Morningstar Advisor - December 2013/January 2014
Contents
Contributors
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster

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