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Pat Dorsey's Picks: Health Care, Tech, Utilities

Pat Dorsey, CFA

Pat Dorsey: Hi, I am Pat Dorsey, Director of Equity Research at Morningstar. As part of Ideas Week here in December, as you are thinking about investments for 2010, where you should be putting new money in your portfolio, I thought we would run through some of our favorite ideas in the equity universe.

Health care is probably most single attractive area that we see right now. We have been saying this all year and it has underperformed all year. Though we think there is still plenty of upside to go. Really, as the uncertainly lifts with health-care reform we think that reform is not coming through as negative as many people might have expected.

If you remember back earlier this year people were talking about single payer health care, the U.S. transforming to a British style national health-care system. That is obviously not coming to pass, which should mean some of the uncertainty gets lifted, and the really very good economics of a lot of health-care companies remain the same.

In pharmaceuticals, probably our favorite name is Novartis, a large Swiss company. It has a big generic asset, as well as some veterinary and vaccine businesses. About three and a half percent yield, based in Switzerland.

Merck might be one of our favorites among the U.S. pharmaceutical companies. Also a very high yield there, cost-cutting coming in ahead of schedule. We really like a lot of the equipment companies as well. Companies like Thermo Fisher Scientific and Covidien that are providing capital equipment to hospitals and life science researchers.

Very, very cheap businesses that have been hurt again by the uncertainty, hospitals and research facilities being less willing to spend. We think that will change in 2010, as the uncertainty lifts and spending resumes, both businesses trading at pretty good cash returns and low price earnings ratios.

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Probably the riskiest name that we like there in the health-care right now, not the riskiest, but certainly riskier than the other ones I mentioned, would be WellPoint, one of the largest managed care organizations. Obviously an area that could very much be in the crosshairs of regulatory change, but incredibly cheap and with economies of scale that we think will keep going beyond the health-care reform.

You have a massive nationwide network of health-care providers that are part of WellPoint, as well as UnitedHealth. WellPoint I like in particular simply because they own a number of the Blue Cross/Blue Shield brand names around the country, which kind of insulates them from the low-cost competition in those areas. So WellPoint trading at about eight times earnings, we think has an enormous amount of upside, but certainly a bit more risk then the other names that I mentioned.

Tech, we are not seeing very much value at all. Probably the only names we would be excited about now would be in semiconductor capital equipment. Companies like Applied Materials, and KLA Tencor. Both of which have very very strong competitive positions, what we would call wide economic moats. A far amount of upsides to the shares, but again pretty economically sensitive, and really some of the only values we are seeing in technology right now.

In basic materials, again the economic recovery has taken a lot of materials names to really what we think are fairly valued to perhaps slightly overvalued levels. Monsanto is one, though, that we would take a look at. The purveyor of Roundup and genetically modified seeds and has really underperformed all year as generic versions of Roundup have come on the market and really hurt that very profitable segment.

We think investors have really been focusing too much on the Roundup troubles and not enough on its core seed business, which really is going to be the growth driver over the next several years going forward.

At their investor day a few weeks ago, we sort of saw the investment community get refocused on that seed portfolio. Shares got a bit of a bounce from $70 to about the $84 level. We think there is a lot more upside from there and that as investors refocus on that seed portfolio, which really is the heart of the company's competitive advantage, that we think the shares should do very, very well going forward.

And finally, in utilities, an area that we have not been very positive on over the past few years, we think that there is some pretty good opportunities for sort of high single digit level total returns.

Two of our favorites there might be Westar; a small Kansas-based electric utility. It has a nice, about six percent yield, it should be able to grow that dividend at a five to six percent rate going forward. A favorable regulatory environment, some good capital spending going on there that should increase the rate base and allow them to keep raising the dividend and growing earnings going forward.

And finally, a bit more risk than Westar, but also a lot more upside would be Exelon, the nation's largest owner of nuclear facilities. About two thirds of Exelon's business comes from the merchant business, unregulated power. They simply sell power on the open market.

And because nukes are a very low cost source of power, really as natural gas prices, which are the highest priced source of power, as natural gas prices go up Exelon's margins get fatter and fatter. Right now we think Exelon's shares are pretty much pricing in the current very low natural gas price environment. But should natural gas prices see some upside in 2010, you could see margins and earnings for Exelon increase quite a bit. And no matter what the scenario is, you have about a nice four and a half percent, very sustainable yield on Exelon.

That is a lot of names for you to think about and a lot of options for you in 2010. Happy hunting.

I am Pat Dorsey and thanks for watching.