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By Matthew Coffina, CFA | 09-15-2014 04:00 PM

The Ones That Got Away

Morningstar's Matt Coffina looks back on some recent missed opportunities and what he learned from them--also, a couple of stocks he's glad he avoided.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Stock investors sometimes regret "the one that got away," a stock that they looked at, decided not to buy, and then that had a great run. I'm here with Matt Coffina--he is the editor of Morningstar StockInvestor newsletter--to talk about some of his missed opportunities and what he has learned from them.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start with the big picture. Is it a good idea for investors to really look back at stocks they didn't purchase and do a postmortem on it? Or should they really just be focused on looking at future opportunities?

Coffina: That's a good question. I think the answer isn't totally obvious. My view is that, yes, it is worthwhile to look back at both the stocks that you bought and the stocks that you passed on to see what kinds of lessons you can learn for the future. But with the big caveat that there are always going to be far more missed opportunities than there are opportunities that you actually took advantages of, especially in a concentrated portfolio.

Our Tortoise and Hare portfolios have less than 20 holdings each. And Morningstar covers some 1,500 companies globally, and there are many more thousands that we don't cover. There are always going to be many more stocks that you missed out on. So, I don't think you should get too bog down on the would-haves, the could-haves, and the should-haves.

If anything, that might make you a little not risk-averse enough when you see in retrospect these companies that did wonderfully; it could be tempting for some investors to chase those opportunities or similar opportunities in the future. It's not always obvious in retrospect what the risks were a couple of years back when you were considering, without the benefit of hindsight, some of these opportunities.

But that said, if you can maintain discipline and maintain focus, I think that it is a good idea to look back and see what went wrong or what you might have missed and what lessons that might hold for the future.

Glaser: What's an opportunity that you passed on and maybe a lesson that you've learned from that?

Coffina: Two, in particular, stand out from the last couple of years. There were two stocks that I was looking at toward the middle of 2013. Apple (AAPL) was one in April 2013; the stock was down about 40% from the previous high. It popped up on my radar; it was trading at a pretty steep discount to Morningstar's fair value estimate.

The other one is Gilead Sciences (GILD), which I was looking at around June-July of last year. In that case, the stock was actually up about 100% from the prior year but still looked pretty reasonably valued relative to Morningstar's fair value estimate. The stock was trading in the low-50s, and I think our fair value was somewhere around 70 at that time. And both of those stocks went on to perform extremely well, vastly outperforming the S&P 500.

So, maybe we'll start with Apple. What went wrong in that case, I think, is that I was overly focused on the long-term risks. Certainly, the history of the consumer electronics industry is not promising. There are plenty of companies like Nokia (NOK) or BlackBerry (BBRY) in the past that have done extremely well and then promptly within a couple of years just fell apart. Apple was basically priced as if that was going to happen to them. The stock, early last year, was trading at about 6.5 times earnings, if you excluded cash on the balance sheet. So, it was basically priced as if the business was going to collapse within the next few quarters, and obviously that didn't happen.

But even at the time, we could have known that that was very unlikely to happen. Apple still enjoyed a lot of brand loyalty. They enjoyed increasing switching costs related to the iOS ecosystem various applications, media content, and so on that people owned within the iOS ecosystem that was tying them more and more into it. So, it was unlikely that earnings were going to collapse. In the subsequent year and a half, earnings were under pressure for a time. They sort of stabilized here. Revenue growth was certainly much slower than it had been in the years prior; but at 6.5 times earnings, Apple wasn't pricing in much in terms of expectations, and I think the valuation more than offset the potential longer-term risks.

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