Two Wide-Moat Firms on Sale
See what the market is missing on these names.
See what the market is missing on these names.
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.
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W.P. Stewart & Co.
Moat: Wide | Risk: Average | Price/Fair Value Ratio: 0.77* | Trailing 1-Year Return: -43.4%
What It Does: W.P. Stewart (WPL) is an asset-management firm that provides equity investment services to clients worldwide. Based in Bermuda, it has analysts and portfolio managers in North America, Europe, and Asia. Many of the firm's clients are high-net-worth individuals. Most of the firm's other business comes from trusts, partnerships, or private corporations. About 30% of the firm's managed assets belong to clients outside the United States.
What Gives It an Edge: W.P. Stewart boasts several attractive attributes. First, the firm is unusually lean, with 100-plus employees supporting roughly $6 billion in assets under management. This has contributed to the firm's strong pretax profitability, with operating margins routinely exceeding 40% in years past. Second, the firm's Bermudan-domicile means that it enjoys a pleasingly low marginal tax rate. Consequently, shareholders get to keep a greater share of the cash that Stewart's business throws off. Third and finally, despite recent travails, Stewart's flagship quality-growth strategy boasts a solid long-term record. While we aren't expecting investors to pump a torrent of new money into Stewart's products, strong performance tends to attract more investors than it repels. Thus, barring a continued malaise, Stewart should at least be able to arrest the outflows that have plagued it thanks to its long-term record.
What the Risks Are: A highly specialized strategy--managing portfolios of blue-chip growth stocks in the private accounts of wealthy individuals and institutions--means that when the stock market tanks, business suffers here. In addition, Stewart is facing increasingly intense competition in the high-net-worth-investor market from larger players, such as brokerage houses, big banks, and hedge funds. Finally, as enticing as Stewart's fat dividend yield might look to income-minded investors, the company's board could cut the dividend in the future in order to free additional cash flow (a step it has taken several times already).
What the Market Is Missing: The firm has suffered a rash of outflows recently amid slumping short-term performance, personnel defections, and intense competition from a host of rivals. The market seems to expect that these problems will persist for the foreseeable future. Our forecast isn't that dire, though it's hardly exuberant. Essentially, we think that Stewart's solid long-term performance record and high-touch client-service model should help to stabilize the asset base, but heavy competition will keep it from landing significant new business. Thus, we're expecting outflows to slow through 2008 and cease altogether by 2009. However, we're not forecasting any inflows thereafter, with market appreciation acting as the lone source of growth. What's more, we're expecting operating margins to hover in the low- to mid-30% range through 2011, which is well below the historical norm.
Procter & Gamble
Moat: Wide | Risk: Below Avg | Price/Fair Value Ratio: 0.82* | Trailing 1-Year Return: 19.7%
What It Does: Since its founding in 1837, Procter & Gamble (PG) has become the world's largest consumer product manufacturer, with a lineup of famous brands. The brands are sold through three global business units and include Tide laundry detergent, Charmin toilet paper, Pantene shampoo, Cover Girl cosmetics, Folgers coffee, and Iams pet food. P&G completed its acquisition of Gillette in October 2005, and since 2001 it has doubled the sales it derives from developing markets.
What Gives It an Edge: P&G is the largest consumer products company in the world, with leading market shares in a variety of product categories. The firm has 22 brands that each generate more than $1 billion in sales annually and another 16 brands that achieve sales of more than $500 million a year. Its ability to build strong brands that appeal to consumers is unparalleled, in Morningstar analyst Lauren DeSanto's view, and while it faces viable competitors in many of its categories, P&G possess tremendous global scale, pricing power, and leverage with retailers.
What the Risks Are: Although DeSanto thinks P&G poses below-average business risk, the firm faces pressure on a few fronts. For one, P&G must develop and support a stream of successful products in a highly competitive retail environment. With such a huge top line, new product launches really need to score big to be considered successful and make an impact on sales growth. Increased raw-material costs, as well as more of its growth coming from lower-margin, developing markets, could keep margin expansion in check.
What the Market Is Missing: DeSanto actually thinks the market knows P&G fairly well. It's a stock that is rarely ever cheap, but right now she suspects the turnaround stories at other firms--like Colgate (CL) and Avon , hold more appeal to the market. P&G, on the other hand, has been busy integrating its $54 billion Gillette acquisition and its recent, third-quarter results met expectations, but didn't beat them. DeSanto believes the market has taken the smooth Gillette integration for granted and has a "ho-hum" attitude toward the firm's healthy performance. It seems to be a case of: So what have you done for me lately? This attitude is a mistake, in DeSanto's opinion, but it's providing a welcome opportunity to get in on an above-average company at a suitably wide margin of safety.
Click here to read more on P&G.
* Price/fair value ratios calculated using fair value estimates and closing prices as of Friday, May 18, 2007.
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