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Stock Strategist

ETFs on Our Buy List

We make our picks from the bottom up.

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One of the many benefits that we accrue from covering 2,000 stocks is the ability to tap our research to value ETFs. Where others might use notoriously imprecise methods like top-down macro forecasting to gauge an ETF's fundamental attractiveness, we're able to go bottom-up, stock-by-stock.

To understand how, consider the largest ETF in the world, SPDRs Trust (SPY), which tracks the S&P 500 Index. We can roll up the fair value estimates that we've placed on more than 470 of the S&P's 500 constituent stocks (representing roughly 98% of the index) in order to derive a fair value estimate for the SPDR. Once we've estimated an ETF's fair value, we can compare it with the fund's price, just as we do in our stock research. The lower an ETF's market price relative to our fair value estimate, the more-attractive we'd consider it, and vice versa. (The SPDR was trading at a 7% discount to our fair value estimate as of Oct. 19, 2007, in case you were wondering.)

Jeffrey Ptak has a position in the following securities mentioned above: JNJ, LOW, USB. Find out about Morningstar’s editorial policies.

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