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Five Stocks to Buy and One to Avoid

Does that cheap stock have temporary or permanent problems?

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I help manage Morningstar's two stock portfolios, the Tortoise and the Hare, both of which have done well since we rolled them out last June. The Tortoise Portfolio, available in our monthly newsletter Morningstar StockInvestor, includes 15 stocks with average or below-average risk. The portfolio has outperformed 95.8% of domestic value funds since its inception.

Whenever I'm thinking about whether to buy a stock for the Tortoise Portfolio, I ask myself whether it meets two criteria. First, does the stock have a sustainable competitive advantage, or what Warren Buffett calls an "economic moat?" And second, is the stock selling at a large discount to fair value? If the answer to both of those questions is yes, then the decision to add the stock to the portfolio is an easy one.

Unfortunately, companies with wide economic moats rarely come cheap. If they did, investing would be a snap. In reality, companies selling at a discount are usually experiencing problems. That's okay with me, as long as the problems are temporary. As an investor, it's my job to figure out the difference between temporary problems and permanent problems. The way I see it, the ability to do that is what separates great investors like Warren Buffett, Bob Rodriguez, and Bill Miller from the also-rans.

Mark Sellers does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.