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Stock Strategist

Stock Star Rating Performance Update

Here's how we're doing so far in 2007.

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The story of the stock market in 2007 so far can be summed up very simply: Large is beating small, growth is trouncing value, and anything related to housing is being taken out behind the barn and shot. The recent performance of our Morningstar Ratings for stocks reflects these trends in spades--especially with regard to housing. Our subpar results over the past year have been dragged down by a number of housing-related stocks on which we turned bullish far too soon.

On the bright side, our results over the trailing three, four, and five years are still ahead of the market, and as you can see in the table below, we've done well relative to the market in most calendar-year periods as well. Moreover, we're still using the same research process today as when we started rating stocks in 2001. Missed calls are part and parcel of investing in the stock market, and while the past year has had more misses than I would like, I don't see anything fundamentally awry with the way we're analyzing and rating stocks. We'll work hard to minimize the misses in the future, of course.

 Calendar-Year Trailing Returns
 Summary Buy at 5,
Sell at 1
Buy at 5,
Sell at FV
Buy at 5,
Sell at 3
S&P 500

S&P 500
Eq-Weight

Year to date 3.5% 1.3% 1.7% 10.5% 8.5%
2006 17.4% 20.2% 23.3% 15.8% 19.0%
2005 7.6% 9.4% 9.2% 4.9% 7.4%
2004 21.4% 26.7% 32.8% 10.9% 17.1%
2003 42.3% 47.2% 44.3% 28.7% 44.8%
2002 -32.8% -37.0% -36.8% -22.1% -16.2%
2001* 2.0% 3.9% 5.0% -11.9% -1.2%
Data from Abacus Analytics, through 09-30-07. * Morningstar began rating stocks on 08-06-01.

The Numbers
As we have for the past few years, we measure our performance by constructing hypothetical portfolios that buy our 5-star-rated stocks, and sell them when they are rated 3 stars, 1 star, or when they reach fair value. All three strategies are perfectly reasonable ways to use our ratings, and which one an investor chooses to use is a matter of personal preference. (Broadly speaking, turnover in a Buy at 5, Sell at 3 strategy is higher than turnover in a Buy at 5, Sell at Fair Value strategy, which in turn is higher than turnover in a Buy at 5, Sell at 1 strategy. So, which strategy you choose to use depends largely on your sensitivity to taxes and commissions.)

In the following table, you'll see time-weighted performance data on all three strategies over a variety of trailing time periods. I've included returns for both the market-cap-weighted and equal-weighted S&P 500 Indexes for reference.

 Time-Weighted Returns
  Buy at 5,
Sell at 1
Buy at 5,
Sell at FV
Buy at 5,
Sell at 3
S&P 500

S&P 500
Eq-Weight

Year to date 3.5% 1.3% 1.7% 10.5% 8.5%
Trailing 1-Year 12.5% 11.2% 13.5% 18.4% 16.6%
Trailing 2-Year 13.3% 13.8% 15.8% 13.6% 12.9%
Trailing 3-Year 14.6% 15.9% 17.5% 13.1% 14.7%
Trailing 4-Year 15.8% 18.0% 19.6% 13.0% 15.7%
Trailing 5-Year 20.3% 22.9% 26.1% 15.4% 19.4%
Since Inception 7.3% 7.9% 8.8% 5.6% 11.4%
Data from Abacus Analytics. Data through 09-30-07.

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Pat Dorsey has a position in the following securities mentioned above: MA. Find out about Morningstar’s editorial policies.

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