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Stock Strategist

20 High-Quality, Cheap Stocks for Last-Minute Shoppers

Looking for ideas? Check out the latest batch of stocks in Morningstar's Wide Moat Focus Index.

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In addition to holiday festivities, the end of the year is also a good time to take stock of what transpired in the prior 12 months and make plans for the coming year. If strategizing about your investment portfolio is part of your year-end routine, we have 20 stocks that you may wish to consider.

During 2009, the stocks that constitute the Morningstar Wide Moat Focus Index handily outpaced the market. This index is composed of the cheapest wide-moat firms in our 1,750-stock coverage universe. Index constituents have among their industries' strongest competitive advantages, which we believe will persist many years into the future.

Only 160 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 ratio) 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 most recent index slightly underperformed the S&P 500 on a total return basis, the first time that has happened in 2009. This index, before its reconstitution, ran from Sept. 21 until Dec. 18 and racked up a 3.6% return over that period, compared with the S&P 500's total return of 3.7%. As of Dec. 18, the Wide Moat Focus Index had increased 46.8% year to date and had a 4.9% annualized return over a three-year period. These longer-term returns are significantly outperforming the market, which ran up 25% year to date and is down 6.1% over three years annualized.

Constituent Performance
As noted, our previous index didn't match the market's returns. Still, 12 constituents posted positive returns during their three-month run.  IMS Health  (RX) led the group with a 33.2% return between Sept. 21 and Dec. 18. In early November, IMS agreed to be acquired at a 50% premium to where its shares were then trading. IMS is no longer a constituent in the latest portfolio.

 American Express (AXP) posted the second-strongest performance in the last index, increasing 17.1%. This stock had a magnificent run in our indexes throughout 2009, gaining 104% in the March-to-June index and 42.1% in the June-to-September index. After its most recent run, it is trading at only a 24% discount to our fair value estimate and was not included in our newest portfolio.

The two biggest laggards in our previous portfolio turned out to be  Apollo Group  (APOL) (-15.4%) and  Boston Scientific (BSX) (-18.9%), although six other stocks had negative returns in the period. Apollo Group's stock got whacked in late October when the firm announced an informal inquiry into its revenue-recognition policies by the enforcement division of the Securities and Exchange Commission. Senior analyst Todd Young believes the market has over-reacted to this news, and Apollo remains in the Wide Moat Focus Index.

Boston Scientific's stock also fell in late October, after the company reported third-quarter results. Citing increasing price pressure and delays in new product launches, senior analyst Debbie Wang  significantly lowered her fair value estimate. Needless to say, Boston Scientific is not included in the latest portfolio.

Despite our 10-basis-point performance miss in the past portfolio, we remain confident that over the long term, strong firms will continue to outperform both weaker firms and the broader market. This is reflected in our 11-percentage-point outperformance on a three-year annualized basis. Even though past performance cannot predict future returns, we believe that our strategy to buy great (wide-moat) firms with significantly undervalued stocks will persevere despite the vicissitudes of the market. As you look forward into 2010, you may want to consider the stocks in our current index.

Company Ticker Fair Value Est ($) Price/Fair Value Fair Value Uncert New to Portfolio? Apollo Group APOL 106 0.55 Medium   Int'l Speedway ISCA 51 0.56 Medium Genzyme GENZ 82 0.59 Medium  Yes St. Joe Corp. JOE 50 0.60 High   GE GE 25 0.62 High   Applied Materials AMAT 22 0.63 Medium   Lowe's LOW 36 0.65 Medium   Monsanto MON 122 0.67 Medium   Exelon EXC 73 0.68 Medium   Time Warner Cable TWC 60 0.69 Medium   Western Union WU 28 0.69 Medium   Stryker SYK 72 0.71 Low   Comcast CMCSK 23 0.71 Medium   Weight Watchers WTW 41 0.71 Medium   Pfizer PFE 26 0.71 Medium   Home Depot HD 40 0.73 Medium Yes Paychex PAYX 42 0.73 Medium   Eli Lilly LLY 47 0.76 Medium   Vulcan Materials VMC 68 0.78 Medium Yes Expeditors Int'l EXPD 44 0.80 Medium Yes

 
The current portfolio contains only four 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 four newbies is  Genzyme (GENZ), trading at 59% of its fair value estimate as of Dec. 23. Senior analyst Karen Andersen is standing by her fair value estimate for Genzyme after the Food and Drug Administration reported foreign particle contamination in less than 1% of product lots in mid-November. Although she's keeping an eye on Genzyme's manufacturing issues, which have cropped up in the past, Andersen believes that the long-term competitive advantages, the history of in-house innovation, and several smart acquisitions are reasons enough to recommend the stock.

Rounding out our group of newcomers are  Home Depot (HD),  Vulcan Materials (VMC), and  Expeditors International (EXPD). While none of these three is cheap enough to warrant our 5-star rating, they are still among our cheapest wide moat rated firms, and therefore are worthy of our attention. Click through to these companies' Analyst Reports or visit Morningstar.com to see for yourself why our analysts are bullish on these undervalued, wide-moat stocks.

 

Mike Taggart does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.