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By Jason Stipp | 01-08-2013 03:00 PM

Top Picks From Morningstar Strategists

The editors of Morningstar's investing newsletters discuss key trends among stocks, mutual funds, ETFs, and dividend payers, and offer their top ideas for 2013 and beyond in this video exclusive for Premium Members.

Jason Stipp: I am Jason Stipp for Morningstar. 2012 offered investors some bumps along the road, a few surprises, and yes, even a cliffhanger at the end. So, what's at stake for 2013 and beyond? We were lucky enough to sit down with four of Morningstar's top strategists to get their take on the current environment and also some of their top picks today.

Up first is Paul Larson, the editor of Morningstar StockInvestor. He looks for wide-moat stocks, selling at attractive valuations. We're going to hear his take on the current market valuation as well as some of his best ideas for 2013.

Paul, before we get to your picks, let's talk a little bit about the broad market and where you're seeing valuations right now. You like to look for high-quality companies, wide-moat companies that are selling at a good valuation, at an undervaluation, a margin of safety. What does your hunting ground look like right now? Are there more opportunities or less opportunities?

Paul Larson: Well, right now, we're in the middle of a bull market. In 2012 we had yet another year of positive returns and strongly positive at that, and for better or worse, that has evaporated a lot of the bargains that we've seen in the market. So, the opportunity set of wide-moat, 5-star stocks or even deep 4-star stocks, that's a very thin cohort right now. You can measure it using one hand.

Stipp: So, that said, you do have a few picks that are on your list right now. The first one, interestingly enough, National Oilwell Varco is led by Morningstar's just-named CEO of the Year, Pete Miller.

Oil and gas is an industry that can be very unforgiving. It's interesting that this firm has a wide moat. I think it says something about the way it operates. What's behind the wide-moat rating on this particular firm in that tough industry?

Larson: I think you have to take a step back and see what the company actually does, and they provide equipment that is used by other E&P firms. So, they are not directly involved in producing the commodities. Instead they're selling the picks and shovels, so to speak, that other oil companies are using to drill their wells.

But what has given this company a wide economic moat is a combination of a few things. One, they have a very large market share among drilling equipment, and this drilling equipment has a fairly high amount of intellectual property in it. And they also turn around and use this scale to get a lower cost and to provide this high-IP equipment to the providers.

Also there's a little bit of a switching costs involved here in that a lot of rigs are standardized around National Oilwell equipment. So, once you're standardized on that equipment, it's fairly difficult to go to a different provider. Also, there's a razor-razorblade component here in that they are providing a lot of the consumables that are actually being used on the rig. So, it's a combination of a couple of different things, but the proof is really in the pudding when you look at the returns on invested capital. They are well in excess of the company's cost of capital, and that's the situation we expect to continue for quite a number of years.

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