Close
ThinkAdvisor

Portfolio > Economy & Markets > Stocks

High-Quality Stocks Selling at Bargain Prices: Morningstar

X
Your article was successfully shared with the contacts you provided.

Morningstar has a message for all those advisors who thought the latest stock market rout created many buying opportunities: You were right.

Almost 38% of the 1700 stocks in its coverage universe are now rated a “buy” or better – the highest percentage seen in almost three years, even after the almost 1,000-point rebound from the closing low during this week’s market swoon.

As of the close on Thursday, 78 of those stocks are “substantially undervalued,” with a 5-star rating from Morningstar.

According to Morningstar, its universe of stocks overall is about 10% undervalued – far less then that 40% to 45% undervalued in 2008 and 2009, but a better buy compared to the last three years, when stocks were fairly to slightly overvalued.

“For those of you who like to buy stocks at a discount to what you think are worth … the last three years have been relatively boring,” said Elizabeth Collins, Morningstar’s director of equity research, North America, during a Webinar this week, titled Finding Buying Opportunities in the Market Sell-Off.  “There haven’t been many opportunities to buy companies trading at a discount to what you think is worth. The situation has changed today.”

Morningstar’s stock ratings are based on a company’s earnings potential, over the next 10 or 20 years discounted back to today, using a discounted cash flow model, then compared to current market prices.

In addition to the usual fundamental analysis, companies are rated for their competitive advantage, or “moat,” with those having the widest moat, or largest “sustainable competitive advantage,” having the greatest earnings potential, said Collins.

Then the analysis is overlaid with an “uncertainty” metric – a gauge of how right or wrong its assumptions may be. The greater the uncertainty, the bigger the discount to the fair value of the stock and the wider the margin of safety in the stock market. High quality stocks with the greatest earnings potential are rated five stars.

 ITC (ITC), an electric transmission company, is an example of a 5-star rated stock with a large sustainable competitive advantage, said Collins. It has a “natural monopoly” because of regulatory protection and should benefit from growing trends away from coal and toward natural gas, wind and solar power, which will all need transmission lines to connect their power to cities.

The stock is trading just over $33 a share, or about 25% below Morningstar’s $42 fair value estimate. “The market is ‘overly concerned’ that regulatory approval will decline in future,” explained Collins.

A very different type of five-star Morningstar rated stock is Procter & Gamble (PG), the giant consumer products company known for Tide, Charmin and Pampers among many other brands.

The company had spread itself too thin, with too many brands and expansions into emerging markets where it didn’t have a competitive advantage, and that has left its stock trading at a significant discount to fair value, says Collins.

Now P&G is turning around, scaling back on unprofitable products and markets and using profits for innovation and marketing, said Collins. But the market is still underappreciating the stock, according to Morningstar. It’s trading just under $71 a share, compared to Morningstar’s $90-a-share fair value estimate. It’s also paying a big dividend, close to 3.7%.

— Related on ThinkAdvisor:

 

 

More on this topic