What the Market's Missing on These 5-Star Stocks

Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.

To get a  complete tally of stocks that have recently jumped to 5 stars--as well as our  full list of 5-star stocks--including our consider buying and selling prices, risk ratings, and moat ratings--simply take Morningstar Premium Membership for a test spin. Click here to sign up for a free trial.

Nighthawk Radiology Holdings
Moat: Narrow  |  Risk: Average  |  Price/Fair Value Ratio*: 0.75  |  Trailing 1-Year Return: -21.7%

What It Does
 NightHawk  provides radiology interpretation services to health-care providers during off-peak hours. The company maintains operations in Sydney, Australia, and Zurich, Switzerland, where its contracted radiologists provide reads during their regular business hours. NightHawk's direct clients include more than 370 radiology groups and more than 90 hospitals, covering 18% of all U.S. hospitals.

What Gives It an Edge
NightHawk is a heavyweight in the nighttime teleradiology industry. While most players consist of a handful of radiologists operating solely within a region or state, NightHawk's 100-plus radiologists and expansive client base (more than 20% coverage of all U.S. hospitals) facilitates a large volume of daily radiology interpretations and makes better use of each radiologist's time, an important factor considering the shortage of U.S. radiologists. NightHawk intends to gain greater scale by acquiring smaller U.S.-based competitors, which will also serve to increase its exposure to the budding daytime teleradiology market. All told, Morningstar analyst Karen Yiu believes that Nighthawk has carved out an entrenched position within an attractive health-care niche, explaining the firm's "narrow" economic moat rating.

What the Risks Are
Yiu rates NightHawk's risk as average, given the noncyclical nature of the radiology industry and the firm's established contracts with its clients and radiologists. The company has no exposure to Medicare and Medicaid reimbursement. However, if its final interpretation business takes off, NightHawk may be exposed to reimbursement risk as those organizations can reduce the profitability of covered services. NightHawk poses nominal financial risk, as it carries no debt.

What the Market Is Missing
Worries about increasing price competition within the industry and uncertainty about NightHawk's position in its new daytime teleradiology business have caused the market to discount the firm's profitable operations, its leading industry position, and its claim over the industry's scarcest resource: U.S. radiologists. Yiu thinks NightHawk's efficient processes, relatively high customer retention rate, and industry growth opportunities make the stock a good bargain at current prices.

Thomson ADR
Moat: Narrow | Risk: Average | Price/Fair Value Ratio*: 0.77 | Trailing 1-Year Return: -3.3%

What It Does
 Thomson   offers digital media hardware, software, and distribution services to the entertainment and media industries. The company operates three divisions: services (DVD, VHS, and CD replication and distribution), systems and equipment (television broadcast cameras and set-top boxes), and technology (patent and software licenses).

What Gives It an Edge
Thomson boasts an edge over competitors in a few areas. Thanks to its new asset base, Thomson has become a centralized provider of digital media solutions and content distribution around the globe. As movie studios and networks continue to demand fast replication and secure delivery of content, Thomson has emerged as one of the few firms capable of satisfying their pressing needs. Given the company's globally integrated processing and distribution capabilities, Morningstar analyst Irina Logovinsky believes Thomson has built a narrow economic moat around its operations. Logovinsky also thinks Thomson's edge in the DVD replication business is helping the company to grow its content services segment (i.e., editing and special effects). The market for such services is still largely fragmented, and given Thomson's resources and existing customer relationships, it should be able to acquire a substantial market share. Furthermore, a continued migration to a digital format should benefit many of Thomson's operations, such as providing cinemas and networks with digital equipment as well as content preparation for digital distribution

What the Risks Are
Thomson faces a multitude of risks, including its ongoing integration of multiple acquisitions and its ability to manage so many new and unfamiliar business lines. The company's DVD replication business is quickly maturing and is more susceptible to cyclical forces. The low-end nature of many of Thomson's current services and customer concentration are also concerns.

What the Market Is Missing
The market is concerned that Thomson's DVD business is going to fall of the cliff due to the proliferation of digital downloading of movies from the Internet. True, the DVD-replication business has decelerated, but that's largely because consumers have finished upgrading their home DVD collections. However, they're still buying DVDs, but now they are more selective, purchasing just their new favorite titles. Logovinsky also thinks we're likely years away from a large-scale shift away from DVDs for a few reasons. First, a lack of digital rights management standards and the slow adoption of fiber-optic cable (capable of quick high-definition movie delivery over the Internet) mean that the DVD business is here to stay, at least for the foreseeable future. Second, movie studios are still dependent on DVD sales, which constitute a large portion of their profits, and studio executives remain very committed to physical media. Third, the DVD business is hampered by a war between two high-definition standards (HD DVD and Blu-Ray), but it should recover once a single standard emerges and consumers start adopting the new technology.

* Price/fair value ratios calculated using fair value estimates and closing prices as of Friday, May 11, 2007.