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Stock Strategist

The Ultimate Stock-Picker's Portfolio Widens Its Lead

Our model portfolio continues to outpace the market.

I recently completed compiling a new watch list from my group of 20 investment managers' first-quarter regulatory filings, which I routinely analyze to ferret out new stock ideas for Morningstar's Ultimate Stock-Picker's Portfolio. However, before revealing the cross section of this new master holdings list and Morningstar's best ideas, I'd like to recap our model portfolio's recent performance, as it continues to be quite good.

Performance Update
Since I last reported performance to you in mid-May, the Ultimate Stock-Picker's Portfolio has grown both on an absolute basis and relative to the growth of the S&P 500. As you can see in the table below, the model portfolio is now outpacing the S&P 500 by more than 400 basis points since inception on Sept. 7, 2006, through June 8, 2007. What's more, the portfolio has demonstrated good absolute performance, with our initial capital growing by almost 21% year to date.

 Ultimate Stock-Picker's Portfolio: Performance Update
  Shares Net
Cost ($)
Val ($)
Tot Raw
Ret (%)
Tyco  380 9984.15 152.00 12,844.00 30.17
Wal-Mart (WMT) 219 9986.21 133.15 11,152.20 12.74
Dell  459 9987.02 -- 12,549.06 25.65
Berkshire (BRK.B) 3 9615.95 -- 10,836.00 12.69
Time Warner  595 9985.15 98.18 12,340.30 24.57
Expedia (EXPE) 599 9992.29 -- 14,004.62 40.15
American Exp (AXP) 174 9965.75 26.10 10,968.96 10.33
Anheuser (BUD) 211 9999.58 186.74 11,098.60 12.86
J&J (JNJ) 157 9976.17 182.91 9,754.41 -0.39
Sprint Nextel  602 9994.11 45.15 13,268.08 33.21
Pulte (PHM) 346 9981.21 41.52 8,944.10 -9.97
Total   109,467.59 865.74 127,733.33    
Cash Balance       5,142.17    
Portfolio Value*   110,000.00   132,875.50 20.80  
S&P 500 Return         16.51  
Outperformance         4.29  
* Beginning portfolio value as of 09-07-06; ending portfolio value as of 06-08-07
** As of 06-08-07

Although I don't believe the portfolio will have this type of performance over every reporting period, I still think these results continue to indicate that my approach has merit, and that the portfolio has the potential to do well over long periods of time--think three to five years.

The main sources of performance have been good returns from  Dell ,  Sprint Nextel ,  Tyco , and  Anheuser-Busch (BUD). The latter two are now both rated 3 stars, fairly valued by Morningstar, and as such, they are both candidates for sale in the portfolio--more on this later.

 Pulte Homes (PHM) and  Johnson & Johnson (JNJ) continue to be the laggards, though I still remain somewhat optimistic on these two stocks going forward. As I've said previously, despite the softening housing market, I remain fairly comfortable with the limited downside risk in Pulte at current prices, and I am cautiously optimistic about the company's favorable long-term prospects. As for Johnson & Johnson, I agree wholeheartedly with Larry Coats of the  Oak Value Fund  when he said in our recent video interview that he doesn't think an investment in J&J is controversial at all. Larry went on to remark that he thinks J&J is a great business, with a great management team, presently trading at an attractive price. My colleague Heather Brilliant shares this favorable outlook on J&J and has the shares rated 5 stars based on her most recent  fair value estimate. I believe that over time this investment will deliver good performance to the model portfolio, and I could be compelled to add more to this position if the shares were to fall even further.

New Watch List
As I mentioned above, two of the portfolio's 11 positions are rated 3 stars (fairly valued) by Morningstar, which means that they are candidates for sale in the portfolio. After discussing the investment in Tyco with our analyst Eric Landry, I've decided to hold on to this stock a bit longer until the management team effects its planned break-up of the conglomerate in the coming weeks. The main reason for this is that depending on the final pricing of the different parts of Tyco, I might want to keep the more moat-worthy businesses in the overall franchise, while jettisoning the others.

 Portfolio Watch List
Company No. of Fund
Fair Value**
Cost of Equity**

3-Year Exp.

Western Union  (WU) 4 0.69 10.0% 24.3%
Bank of America  (BAC) 4 0.72 10.5% 23.4%
Medtronic  (MDT) 4 0.81 9.0% 16.7%
Procter & Gamble  (PG) 4 0.82 8.0% 15.4%
Lowe's  (LOW) 4 0.82 9.5% 16.9%
eBay  (EBAY) 3 0.64 10.0% 27.6%
Capital One  (COF) 3 0.70 11.5% 25.8%
WaMu  (WM) 3 0.74 11.0% 23.0%
Countrywide   3 0.74 11.0% 22.9%
Sears   3 0.74 10.5% 22.2%
Apollo Group  3 0.74 10.0% 21.6%
* Fund holdings data as of 03-31-07
** Morningstar data as of 06-08-07

Anheuser-Busch is the other stock that is currently a candidate for sale, and I am presently considering replacing it with either an investment in  Bank of America (BAC),  Medtronic (MDT),  eBay (EBAY), or  Capital One Financial (COF) from the most recent watch list in the table above. Here are is an analyst snapshot of our take for each of these companies:

Morningstar analyst Ganesh Rathnam recently wrote about Bank of America: "Perhaps the biggest growth driver for B of A is its wealth-management business. Including its Columbia mutual funds, B of A already has more than $500 billion in assets under management. However, only 10% of B of A's estimated 8 million affluent customers currently avail themselves of its wealth-management products. B of A can rapidly increase fees in this division just by roping in more of its checking account customers. Retail and corporate bank employees are given incentives to make referrals to the private bank. We believe that B of A holds an edge over competitors like  UBS (UBS) because of its ubiquitous branch network."

My colleague Debbie Wang has said about Medtronic: "We're impressed by the firm's persistent ability to innovate, and by how it's often first to market with new products. For instance, Medtronic's promising new spinal bone graft product remains the only one of its kind on the market. Because this novel device contains recombinant bone protein that induces the patient to grow new bone, it is considered superior to traditional lumbar-fusion procedures--it's less invasive and spares patients the stress of grafting bone from other body parts. The firm already has a second bone morphogenic product in development. Additionally, Medtronic is one of the leaders in developing sensors that constantly monitor blood sugar levels in diabetics. Sensors that measure blood glucose 280 times a day would offer a significant advantage over the traditional four-times-a-day finger pricks that most diabetics perform to monitor blood sugar, leading to better blood sugar control and fewer disease complications. Medtronic is also leading the way to create monitors that work automatically with insulin pumps to release insulin at the appropriate times. This brings Medtronic one step closer to an artificial pancreas--the holy grail of diabetes care devices."

John Owens continues to maintain his favorable opinion on eBay's shares, recently commenting on PayPal and Skype's impact on the company's first-quarter results: " We continue to be impressed by PayPal, which increased revenue 31%, to $439 million. The leading online payment service further increased its penetration on the eBay platform and saw continued success in signing up new merchants off the platform. Skype also continued its meteoric growth, generating $79 million of revenue, up 123% from the prior-year quarter. We were very pleased to learn that Skype achieved its first quarter of profitability."

My colleague Michael Kon recently wrote about Capital One: "Several acquisitions transformed Capital One into a collection of good businesses that operate alongside one another. More than 70% of the profits come from the consumer lending segment, which includes the legacy U.S. credit card business, auto finance, mortgage banking, and credit card businesses in the United Kingdom and Canada. We think Capital One's scale and brand name are major competitive advantages that will benefit the firm in the long run. Capital One is one of the top five credit card issuers and auto lenders in the U.S. The firm also ranked among the top 20 mortgage originators in 2006. Thanks to its national scale and an ingenious marketing campaign, its brand is one of the most recognized in the financial services sector. In addition, having national scale allows Capital One to extract valuable information on consumer spending trends. With this information, Capital One can make better decisions regarding cross-selling initiatives, new product introductions, pricing strategies, and market opportunities and risks. Only a few firms in the country have access to such information, and Capital One is fortunate to be one of them."

Stay tuned for an update in the next week or so, when I finalize my decision on the new position for the Ultimate Stock-Picker's Portfolio. In that report, I'll detail my thought process in weighing the different potential outcomes of a particular stock selection. If you haven't already, please sign up for my e-mail alerts now so you can be among the first to see my new pick for the portfolio.

Click for the portfolio's investment manager watch list
and the most popular stocks in their combined holdings >>

Justin Fuller has a position in the following securities mentioned above: AXP, APOL, DELL, PG, PHM, MDT, COF, CFC, EBAY, WU. Find out about Morningstar’s editorial policies.