20 High-Quality Stocks to 'Fall' Back On

Autumn is upon us, and let's hope the harvest moon shines as brightly as the market did over the summer. Recent returns to U.S. equity investors went a long way toward making up for the cold shoulder we got in 2008.

Once again, returns were even better for the portfolio of stocks that comprise our Morningstar Wide Moat Focus. This index is composed of the cheapest wide-moat firms in our 1,800-stock coverage universe. Index constituents are firms with the strongest competitive advantages in their industries and the ones where we believe the advantages will persist many years into the future.

Only 175 companies that we cover (fewer than 10%) bear our wide economic moat rating. For inclusion in this index, we pick the 20 cheapest (based on stock price/fair value) wide-moat firms every three months, and we readjust the holdings to equal-weight them at 5% of the portfolio apiece. These are not necessarily 5-star-rated picks, but the cheapest wide-moat stocks we have to offer. The result is a fresh collection of high-quality firms with undervalued stocks.

The previous index, before its reconstitution, ran from June 22 until Sept. 18 and racked up a 22.4% return over that period, compared with the S&P 500's total return of 16.6%. As of Sept. 19, the index had increased 41.6% year to date and had a 6.0% annualized return over a three-year period. These longer-term returns are also significantly outperforming the market.

While nearly every stock in the previous portfolio increased in value from June to September, four had returns in excess of 40%.  Harley-Davidson (HOG) (52% return),  American Express (AXP) (44%),  KLA-Tencor (KLAC) (42%), and  Time Warner Cable  (42%) were the standouts. Harley-Davidson and Time Warner Cable were added to the index only at its prior rebalancing in June, and Harley-Davidson is no longer a constituent as its runup made it ineligible for the current portfolio. It's always nice to have big winners right away. American Express has continued its hot streak, having also increased 104% in the March-to-June index, yet it remains in the current portfolio at a price/fair value of 63%. We still believe Amex has plenty of upside. The only stock in the previous portfolio not to post a positive total return was  Eli Lilly (LLY), which lost 1% in the period.

Autumn has historically been a difficult time for the broader stock market, and this year many investors are especially anxious due to the market's run since March. Despite the uncertainty, we remain confident that over the long term strong firms will continue to outperform both weaker firms and the broader market. We believe that our "buy great firms with significantly undervalued stocks" strategy will persevere despite the vicissitudes of the market, even though past performance cannot predict future returns. Given the uncertainty so characteristic of autumn, you may want to consider hunkering down with the stocks in our current index.

Current Constituents of Morningstar Wide Moat Focus Index*

Company Ticker FV Estimate Price/FV FV Uncertainty New to Portfolio? International Speedway ISCA 51 0.54 Medium   IMS Health, Inc. RX 26 0.58 Medium   Boston Scientific, Inc. BSX 18 0.59 Medium Yes Applied Materials AMAT 22 0.59 Medium   St. Joe Corporation JOE 50 0.59 High   Lowe's Companies Inc. LOW 36 0.59 Medium   Eli Lilly & Company LLY 54 0.6 Medium   American Express AXP 54 0.63 High   Monsanto Company MON 122 0.63 Medium Yes Stryker Corporation SYK 72 0.63 Low   Pfizer Inc. PFE 26 0.63 Medium   Paychex, Inc. PAYX 46 0.63 Medium   Comcast Corporation CMCSK 25 0.64 Medium   Weight Watchers Intl. WTW 41 0.66 Medium Yes Exelon Corporation EXC 76 0.66 Medium Yes General Electric Company GE 25 0.66 High Yes Zimmer Holdings, Inc. ZMH 78 0.67 Medium   Time Warner Cable TWC 60 0.69 Medium   The Western Union Company WU 28 0.69 Medium   Apollo Group, Inc. A APOL 100 0.71 Medium Yes

* Data as of Sept. 24, 2009

The current portfolio contains six newcomers--firms that weren't cheap enough to include in the prior portfolio but are cheap enough for us now. The most undervalued of the six is  Boston Scientific (BSX), trading at 59% of its fair value estimate as of Sept. 24. Senior analyst Debbie Wang believes Boston Scientific struggled with a large case of indigestion after its pricey Guidant acquisition and a stent market slowdown. However, the stent and cardiac rhythm management markets have now stabilized, and even with her conservative expectations for near-term performance she believes this stock is undervalued. It's one to keep an eye on, for sure.

 Monsanto  is the penultimate undervalued new addition, trading at 63% of our fair value estimate. Senior analyst Ben Johnson likes this seed producer. "Monsanto is a fierce competitor that continues to dominate a market that it essentially created more than a decade ago. Through its ongoing commitment to research and development and assertive capital allocation, the company has positioned itself to grow value for its shareholders over the long haul." You may want to consider planting this stock in your portfolio.

Rounding out our group of newcomers are  Weight Watchers (WTW),  Exelon (EXC),  General Electric (GE), and  Apollo Group . Click through to the companies' Analyst Reports or visit our Web site to see for yourself why our analysts are bullish on these undervalued, wide-moat stocks.