With the stock market on a tear, finding undervalued stocks with large margins of safety is becoming increasingly difficult.
This article first appeared in the April/May 2011 issue of Morningstar Advisor magazine. Get your free subscription today!
Health care, specifically large-cap pharmaceuticals, have lagged behind consumer goods and basic materials, however. Fears of weak pipelines and patent cliffs have prevented shares from participating in the rally, but Morningstar's analysts think that several great companies in the sector still look undervalued.
Sector = Health care
We begin the screen by focusing in on health-care companies. Firms in the health-care sector range from small speculative biotechnology stocks to long-established titans of business.
And Morningstar Rating > 3
Our goal is to focus on companies with large margins of safety, so our screen will focus on companies rated at least 4 stars, which implies a fairly significant discount to Morningstar analysts' fair value estimates.
And Economic Moat = Wide
The next step is to focus on companies that have sustainable competitive advantages, which can range from patents, to brands, to sheer size and scale. Wide moats are generally an assurance that the business is unlikely to fail anytime soon.