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June/July 2009 Picks

Four offerings deemed to be right for right now.

Morningstar Analysts, 06/03/2009

Stock: Becton, Dickinson and Company BDX
Becton made a name for itself manufacturing basic surgical instruments: needles, syringes, scalpels, and more. As the industry evolved, so did the company's products, and many significant technological innovations were first introduced by Becton. The launch of safety-engineered products designed to prevent needle-stick injuries is among the firm's latest achievements; these products are now mandatory in most U.S. hospitals. Becton has also been advocating greater use of safety products overseas, and its push is paying off. The essential and thus recurring nature of Becton's medical products, which account for nearly half of its total sales, is allowing the company to weather the storm of a hospital spending freeze. It also affords Becton flexibility in capital deployment, which the company takes full advantage of by investing in rapidly growing diagnostic and flow cytometry product lines. While growth opportunities still persist within the medical business lineup, the needle market is rapidly becoming saturated, particularly in the U.S. Hence, we expect diagnostic and bioscience operations will become the firm's primary growth drivers in the upcoming years. Becton's recent expansion into genetic and oncology diagnostics has already produced several intriguing product launches, particularly its staph infection (MRSA) detection technology.

Our favorable take on Becton's prospects also stems from our confidence in the firm's management. The company's reputation for searching out pockets of growth, along with its sizable manufacturing and distribution infrastructure, convinces us that Becton will be able to fend off competition and continue to defend and widen its economic moat. By Haywood Kelly

Exchange-Traded Fund: Vanguard Dividend Appreciation ETF VIG
Vanguard Dividend Appreciation charges only 0.28% a year to invest in an index of U.S. blue-chip companies that have increased their dividends for at least 10 years in a row. An incredible 90% of the assets in this portfolio boast either a wide or narrow moat according to our equity analysts, and 85% of assets are invested in companies with low or medium uncertainty. These statistics beat out nearly every other nonsector ETF in our database, with only the Dow Jones Industrial Average tracker DIAMONDS DIA approaching the same quality of names. VIG's portfolio has a debt/capital ratio lower than all other ETFs of similar quality except health-care-sector-specific funds, which should help as the credit crunch begins to hurt leveraged firms. This portfolio trades at a sizable 23% discount to fair value as of the April 30 market close. While this is a slightly higher price relative to fair value than most broad indexes, we don't mind paying up for names this good. Finally, the broad mix of stocks appeals to us, with this ETF's substantial stakes in industrials, materials, and consumer discretionary sectors. Despite the name, the yield of the underlying portfolio is an unspectacular 3.1%, but that yield will remain safe for years to come even as much of the S&P 500 sees its dividends slashed. By Bradley Kay

Mutual Fund: Third Avenue Small Cap TASCX
This fine fund is down but far from out. It trails most of its rivals over the past year. That's not unfamiliar territory for the fund as it has had dry spells before. The difference is it has periodically lagged in buoyant markets but now finds itself in relatively uncharted waters, losing more than its rivals in a downdraft. We didn't see it coming but retain full confidence in manager Curtis Jensen. He has built a tremendous long-term record here applying Third Avenue's safe and cheap approach, which targets firms trading at big discounts to their underlying assets. This portfolio of cheap stocks has simply gotten cheaper over the past year, but its holdings are far from impaired. So we think this fund looks great going forward. Its price to prospective earnings is just 7.7 and its price/book ratio is a mere 0.66. Both are well below the small-value category average. We also like that Jensen is flexible. He recently bought a few distressed debt positions, leveraging Third Avenue's expertise in that area. All are senior notes paying huge yields. We retain full confidence in this fund. By Michael Breen

Separate Account: Delafield Value
Delafield Value is a hidden gem. It's run by Dennis Delafield and Vince Sellecchia, who have built a strong record by staying in their circle of competence. This separate account and its mutual fund sibling Delafield DEFIX have always kept a slug of assets in industrial-materials stocks, an area where the managers have proved great at identifying catalysts to jump-start firms' results. They currently have more than 60% of assets parked in industrials, but this isn't a top-down sector bet. The managers are pure bottom-up investors who buy firms with solid cash flows whose shares are trading at a discount to their estimate of intrinsic value because of near-term challenges. The duo says a deteriorating global economy has hammered shares of industrial firms, giving them a chance to build positions in several top operators at big discounts. They added to Acuity Brands AYI, a maker of electrical equipment and lighting, as it tumbled in late 2008. The team says the firm is set to improve margins after spinning off its specialty chemical unit. Acuity trades at a price/earnings ratio that is less than half its industry's average, despite having a solid balance sheet and prodigious free cash flow. The portfolio is full of such cheap but viable firms. It has held up comparatively well in the bear market despite its economically sensitive nature and stands to benefit more than most in a recovery. By Michael Breen

Hindsight: Fall 2007
It's mea culpa time. The picks we made in our fall 2007 issue have performed abysmally as a group. Less than half of them have beaten their broad market bench- marks since we recommended them. On a dollar-weighted basis, they're even worse. Our stock picks did most of the damage. Borders Group BG, CapitalSource CSE, and Crosstex Energy XTEX have all shed more than 90% of their value. All three have been crushed by the economic downturn and are struggling to restructure in hopes of staying going concerns. There's no guarantee they'll succeed. Telecom Corp of New Zealand NZT has shed 60% of its value, but we think it has staying power and will bounce back. Our ETF picks also lag their broad benchmarks, but by a much smaller amount. We've soured on SPDR KBW Bank KBE because of the uncertainty brought by government intervention in the financials sector, but we still like our other picks. The bright spot was our mutual fund picks. All four are handily beating their respective benchmarks, and we remain high on all of them. And our separate account picks mostly got the job done, with two of three besting the market. Check out the results here.

By Michael Breen

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