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By Damien Conover, CFA | 07-27-2015 12:00 PM

2 High-Quality Health-Care Bargains

Merck and Biogen boast strong pipelines and are in strong positions for long-term growth--and they're undervalued, says Morningstar's Damien Conover.

Damien Conover: Here at Morningstar, it's important for us to get our economic moat ratings correct. So, on the health-care team, we've looked back at the last decade and a half to see how our moat ratings have changed. By a factor of 2 to 1, we've increased moats to decreasing moats.

One of the main drivers within the health-care space is pharmaceutical firms and biotechnology firms. Within those firms, innovation really leads to moat expansion. The reason moat expansion is important is if you think about the performance of our 25 cheapest wide- and narrow-moat firms over the last decade and a half, those stocks outperformed the associated index by about 800 basis points. So, when we do upgrade a moat within the health-care space, we tend to increase valuation by about 5%.

Looking forward, a couple of names we think are significantly undervalued and have wide moats are Merck (MRK) and Biogen (BIIB). Both of these firms have very strong pipelines and their patent exposure isn't overly significant. So, not only do we think they are in a good position to have strong returns on invested capital, we think they are in a strong position for long-term growth as well.

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