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By Jeremy Glaser and Michael Holt, CFA | 03-04-2013 01:00 PM

With Indexes Rising, Any Bargains Left?

The Dow is at all-time high levels, but Morningstar's Mike Holt says buying opportunities still exist across all sectors and emphasizes the importance of individual stock selection.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. As many of the major indexes approach their all-time highs, I thought would be a good time to sit down with Mike Holt. He is our director of equity research for North America. We are going to look at valuations and see if there are any values left today.

Mike, thanks for joining me.

Michael Holt: Thanks for having me.

Glaser: As stocks get closer to these nominal highs, do we think the entire space is just very overvalued? How would you characterize the valuation of stocks right now?

Holt: Even though we're approaching a high as far as the indexes are concerned, when we look at our coverage universe we see that the universe is actually about fairly valued. So, when we look at what our estimates are for all these individual companies are in terms of what we think their intrinsic value is and how that compares with their trading, we see that the universe is trading right at 1.00.

Glaser: So, if stocks look to be fairly valued and fully valued what are some of the assumptions underlying that? Do we think that there could be more productivity gains? Do we expect growth to continue? How are the analysts thinking about that?

Holt: Yeah, implicitly in our models there is basic economic growth built in. That reflects the deleveraging we've seen since the downturn. It reflects stabilization of the housing market, return of consumer spending, those general assumptions.

Glaser: So, with stocks being fully valued you don't get a lot of margin of safety. So when you talk about wanting to buy stocks cheaply and something doesn't go exactly right, you have some wiggle room there. Without that margin of safety, how do you protect your downside? How do you think about that?

Holt: That's a great question because we really want to focus on business quality. So, when you start to see stocks that are fairly valued or even overvalued you want to look at business quality. Our research has shown, though, it's not enough to focus on business quality alone, but you want to add a lens of valuation. So, when you look at business quality and valuation that's where you have a recipe for success over long-term investing.

Glaser: So, business quality being a proxy, for say, an economic moat…

Holt: Absolutely.

Glaser: So, the longer you are able to fend-off your competitors, the better off you are going to be.

Looking across sectors right now, is the valuation pretty much even, or are there certain parts of the market that look maybe a little bit frothy and some that look undervalued?

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