Stocks with rock-solid balance sheets and strong competitive advantages are the best for investors looking to deploy cash after the correction, says Morningstar's Heather Brilliant.
Jeremy Glaser: For Morningstar, I am Jeremy Glaser. The Dow fell by more than 500 points on Thursday as investors fretted about the lack of economic growth and the European sovereign debt crisis. I'm here today with Heather Brilliant. She is the head of Equity and Credit Research at Morningstar. We'll take look at the slowdown, what sectors could be the most affected, what changes there could be to the firm's valuations and our fair value estimates, and where investors can put some money to work today.
Heather, thanks so much for talking with me, today.
Heather Brilliant: Thanks for having me, Jeremy.
Glaser: So, let's start off with a little bit about this big sell-off that we saw. In terms of general valuation levels, were you surprised to see a sell-off or correction of this magnitude right now or were we thinking that stocks were a little bit overpriced and this was more coming back closer to fair value?
Brilliant: I think, whenever you see a correction of this magnitude, it is always stunning. You never really expect to see the market fall 500 points in a single day. It hasn't happened since the financial crisis in 2008, and even then it was obviously shocking, every time it happened. So, with that being said, I think, fundamentally, we weren't too surprised to see market correct a little bit. It maybe has overreacted at this point, but we were expecting the fundamentals would start to more accurately reflect what we saw in stocks, which is that the economy was not really all that strong.
Glaser: So, how does that trickle down to your fair value estimates then? Would you expect with this slowdown, both in the economy and in the stock market, kind of a wholesale revision to fair value estimates or cost sectors, or do you think that the analysts are pretty comfortable with where they are right now?
Brilliant: On average, we think we're pretty comfortable with where we are right now. We'll certainly be taking a look at a couple of individual cases where we think that what's happening right now and the economic data that's coming out could indicate a weaker picture for some companies. But in the aggregate, we really do expect that our fair value estimates will stay relatively constant. We've built in a lot of economic slowdown as a possibility into our fair value estimates. So, maybe the percentage is increasing of how likely we think a slowdown is, but it's still not to the extent that we'll see any kind of wholesale changes.
Glaser: So, looking at individual sectors that have corrected, are you looking at industrials, which is an area that we've seen a lot of poor economic data that's already baked into those fair value estimates in that sector?
Brilliant: I think it largely is in industrials. The data has been getting weaker in industrials for a couple of weeks now, and it's something also that as the market rallied and as the economic indicators were getting stronger, we were actually starting to scratch our head and think, "Wow, it looks like the data is coming in a lot stronger than we had expected." So we still stuck to our fair value estimates. So, we were basically thinking the market was pretty overvalued for industrial names.
Glaser: One thing that we have seen during the last couple of quarters is that high-end consumers have been performing surprisingly well, with kind of the lack of the negative-wealth effect, if you will, of losing this much in one day. Do you see a big impact in consumer discretionary?
Brilliant: We are little bit concerned that this kind of impact in the market, when you see the market fall this quickly. If you are a higher-end consumer, you might start to worry about your portfolio and what impact this will have on your ability to spend. So, we do think this could hit the luxury stocks pretty hard. We do have a lot of the names actually at price/fair value ratios in the neighborhood of 20%-50% overvalued right now, so we wouldn't be surprised to see companies like Nordstrom or Tiffany see weaker quarters in the coming months.
Glaser: So they could have some room to fall. In terms of putting money to work, certainly there are a lot of stocks that are starting to fall, but that doesn't mean that all of them are great values. What would you be looking for in stocks for investing in today?
Brilliant: I think there are really two key elements that investors should focus on in an environment like this, and it really can be a buying opportunity. It might take a while to play out, but when you see the market fall this far, this fast, you really have to think, "How can I find an investment that will be high-quality and will last through any downturn that might be coming up?" So we would recommend looking at names that have a strong economic moat either a wide moat or narrow moat and companies with very strong balance sheets.
Glaser: They want to make sure that they have the financial wherewithal to make it through another potential crisis. Do you have some specific names that might fit those criteria?
Brilliant: Sure. Yes. We would recommend taking a look at names like Procter & Gamble. Pepsi is the name that we just recently added to our best ideas list. We think Pepsi looks very interesting at these levels. We'd also recommend investors take a look at the large-cap tech space which has been really beaten up, really in the recent 12 months. Names like Cisco and Hewlett-Packard look particularly cheap to us.
Glaser: Well, Heather thanks so much for talking with me today.
Brilliant: Thanks, Jeremy
Glaser: For Morningstar, I am Jeremy Glaser.
