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Wide-Moat Picks for a Slowdown

Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm very pleased to be joined here by Heather Brilliant. She is the head of our global credit and equity research, and she is going to give us some wide-moat picks for the slowdown.

Heather, thanks for joining me today.

Heather Brilliant: Thanks for having me, Jeremy.

Glaser: So let's first take a look at just what's happened in the equity markets in the last couple of weeks. We last talked in August when things were really selling off pretty sharply, and we've seen that sell off again [recently]. Have you seen kind of the fundamentals of businesses really deteriorate a lot in that timeframe?

Brilliant: We really haven't seen a lot more fundamental deterioration. There have certainly been signs that things are not recovering as quickly as we would like to see, but by no means are things falling off the cliff, the way the market would seem to indicate over the last couple of months.

Glaser: Has this been true across all industries? I know there has been a lot of focus on financials in particular, as being exposed to Europe. Have you seen some sectors holding up a little bit better than others?

Brilliant: I think you saw a lot of the downside in health care come earlier, so when people started first worrying about the economy impacting health-care stocks, they got hit. So there wasn't a lot more downside to be had there. But when you look at really cyclically exposed sectors, like industrials, I think we've seen them get a lot harder hit lately.

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Glaser: So we're seeing this incredible volatility, where even intraday we're seeing many hundred-points moves in the Dow and other major indexes. What should investors do? It's kind of easy to say we should just sit back and stick to our guns, but what kind of stocks should individual stock investors be focused on in times like this?

Brilliant: We really think individual investors should focus on high-quality names that are trading at a discount. There is really a rare opportunity here to buy some really high-quality firms, wide-moat companies, at a meaningful discount to what we think they are worth, and I think investors would be best suited to focus there.

Glaser: So some of those no-moat stocks have gotten hit pretty hard?

Brilliant: Especially over the last month, but even over the long term, we really see no-moat stocks underperform wide-moat stocks that you buy at a discount. So it's really, I think, a solid investment strategy to focus on quality.

Glaser: So when you look at stocks in both the United States and abroad, particularly in the United States, do you think firms are well positioned? If we have another slowdown, if we do have a double-dip recession, are we going to see the kind of defaults, the kind of stress we saw in 2008 over again?

Brilliant: I certainly don't think so. I think that the U.S. corporate companies especially have really spent a lot of time trimming the fat from their corporate structures and making sure they are well positioned to withstand a further downturn. So I expect those stocks to do much better going forward. There is a lot of cash on corporate balance sheets, especially among U.S. companies, and I think you'll really see that benefit them if we do continue to see the economy stay really down in the dumps.

Glaser: Let's go ahead and take a look at some of those individual wide-moat names. What are some places that you think investors could put some new money to work?

Brilliant: Well, I think there is a lot of opportunity, actually, among wide-moat firms that are trading at a discount. In fact,  among our 165 or so wide-moat companies that we cover, 32 of them are trading at prices that we would consider worthy of considering buying. Among those we've picked out a few that we think look particularly cheap.

Avon is one that I would mention. Avon is trading around $19 lately, and we think it's worth $36. So there is lot of upside to what is a very globally exposed business that can really benefit from growth in emerging markets and has really gotten disproportionately hit lately. So we think it has almost 50% upside from where it's trading now and even on a P/E basis, it's trading at less than 9 times earnings, so we think it looks really attractive.

Glaser: I know that basic materials and energy stocks have been hit pretty hard as people are afraid that demand for these materials is going to go down. Do you have any picks in that space?

Brilliant: Sure. You don't even really go down into the weeds to find a very great investment opportunity in energy, specifically ExxonMobil. Exxon is actually trading at about 25% discount to what we think it's worth. It's trading about $73, and we think it's worth $99 a share, and that is only 8 times P/E. And also, Exxon pays a 2.5% dividend. Among the companies that we're talking about today, they all pay a dividend. So you actually get paid better than Treasuries to hold really strong balance sheet companies.

Glaser: It's always nice to be get paid to wait.

Brilliant: Yes. Because you could be waiting a while. I think that's a really important point in this environment. None of these stocks may recover tomorrow. They could, but that's not really what we're talking about here. We're really looking for ideas that we think investors should be willing to put in their portfolios and not worry about for several years.

Glaser: You mentioned that health care had been hit kind of earlier when concerns about the economy cropped up. Are there any names in that space that still look undervalued?

Brilliant: We think that Novartis and Medtronic both look undervalued. Novartis in the big pharma space, which clearly also has exposure to generics, which is a very fast-growing area within the pharmaceutical industry and also very fast-growing in emerging markets--one of the strongest potential areas, I think, in the market over the next couple of years.

Medtronic in medical devices is really well-positioned in China, specifically. They have built some factories and done some training of doctors in China, so that when you see the growing middle-class come in China, you'll really be able to be invested in a company that can benefit from that.

Glaser: Well, Heather, I really appreciate the picks today. Thanks for joining me.

Brilliant: Thanks, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.