Best Stocks for 2018
These large-cap picks are likely to stand the test of time.
It's 2008, and fears abound in the market. A housing meltdown, credit crisis, and $100-per-barrel oil weigh on investors' minds. Political turmoil overseas, global warming, and a wide-open U.S. presidential election further cloud the future. A recession may be around the corner, and the risk of inflation could tie the Federal Reserve's hands. Although these fears may be valid, at Morningstar, we emphasize that truly great companies will produce outstanding long-term returns, regardless of the political climate, the Fed's latest move, or when the housing market recovers.
At the start of any year, we often see articles that attempt to zero in on the "Best Stocks for the Coming Year." For 2008, many will emphasize recession-proof stocks, companies unconnected to the housing market, or stocks that can benefit from the booming commodities markets. However, such a short-term focus can be borderline backward-looking, and many stocks featured in such articles may wind up better known as the "Best Stocks of 2007." We're in it for the long haul, and we use forward-looking valuations to seek out firms with sustainable competitive advantages that currently trade at a discount to what they're really worth. With a little patience, we can take advantage of the market's disquiet to root out long-term opportunities.
We've compiled a list of five companies with stocks that are well-positioned to outperform in the coming decade. These firms share two key qualities. First, they possess either a wide or narrow moat that should remain intact--if not widen--through 2018. Second, transient negative news has driven their share prices into bargain territory. Each carries our 5-star rating as of this writing, meaning that their shares can be purchased for considerably less than where we peg their intrinsic values.
McGraw-Hill Companies (MHP)
Standard & Poor's credit rating business took a hit in 2007, as new debt issuance slowed and its opinion on many mortgage-backed securities proved overly sanguine. We think the credit market turmoil has created a buying opportunity, as the company's wide-moat business model remains intact. S&P shares a toll-collecting duopoly in credit rating with Moody's and has significant international growth prospects, as public debt markets begin to displace bank loans as a primary funding source. We also like McGraw-Hill's textbook publishing business, which benefits from economies of scale and limited competition in the elementary- and high-school markets.
The weak U.S. housing market has been a drag on Cemex's shares, which trade at less than 8 times free cash flow. Because of high transportation costs, cement plants tend to operate as local monopolies, allowing Cemex to raise prices ahead of inflation. The company has opportunistically expanded around the globe, and benefits from logistical efficiency and inland assets that face less competition. Since cement is an essential ingredient in almost all major construction, we believe demand growth will continue to track real gross domestic product growth over the long run.
Amgen was another victim of 2007, albeit for reasons completely unrelated to housing. Safety concerns over the company's best-selling anemia drugs led to strict Medicare reimbursement restrictions and plummeting sales. We think the company's wide moat is intact and will persist through the next decade. Amgen has best-in-class research, sales, and manufacturing capabilities, which give it a significant advantage when in-licensing new drugs from smaller competitors or developing treatments in house. Thanks to patent protection, insurance coverage, and the life-saving nature of many of its products, Amgen has pricing power and sustainably high margins. Aging populations in the United States, Europe, and Japan add a demographic stimulus, while the company's deep pipeline promises to fill the gap left by its embattled anemia franchise.
Western Union (WU)
Western Union has had a bumpy ride since being spun off from First Data in 2006. Declining construction employment, anti-immigrant sentiment in the United States, and concern about emerging competition from new money-transfer technologies have weighed on the stock. Through it all, Western Union has continued to generate abundant free cash flow and impressive growth, especially in underserved overseas markets such as China and India. We think Western Union's vast agent network, economies of scale, and recognized brand will keep competition at bay, while its customers' reliance on cash implies that technological obsolescence still lies far in the future. With only a 17% share of a growing market for remittances, Western Union's growth prospects over the next 10 years are robust.
Legg Mason (LM)
Poor performance in its equity mutual funds and exposure to asset-backed commercial paper in its money-market funds eroded the market's confidence in Legg Mason in 2007. We think this wide-moat asset manager will survive these setbacks relatively unscathed and prosper over the coming decade. With sticky assets, fat operating margins, scale advantages, and market returns providing a natural impetus to high, sustainable revenue growth, asset management is one of our favorite businesses. Besides its admirable track record, diverse fund offerings, and nearly a trillion dollars under management, Legg Mason is the most undervalued asset manager we cover.
Ryan McLean, Michael Corty, Matthew Warren, Karen Andersen, Brett Horn, and Andrew Richards also contributed to this article.
Matthew Coffina has a position in the following stocks: CX, AMGN, WU.
Matthew Coffina does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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