Which Stocks Do Morningstar Analysts Own?
We asked five analysts to share their rationale for their top personal holdings.
Morningstar's 90 equity and credit analysts are passionate about investing. Not only do we spend all day examining and evaluating companies as an integral part of our jobs, but many of us also spend time after work investigating companies for our personal portfolios. There's no better endorsement of a company than investing your own money in its stock, or having "skin in the game." So, we decided to ask a few Morningstar analysts to choose one of the top holdings in their personal accounts, and to tell us why they own it.
Morningstar analysts are not allowed to own shares of either the companies they cover, or their direct competitors, because we want to avoid any potential conflicts of interest. We also don't always agree amongst ourselves. Valuation is not an exact science. An analyst who formally covers--but does not own shares of--a given company might think it is fairly valued, while another analyst who owns--but does not cover--the company's shares may be more bullish on its valuation. One thing we all agree on is Morningstar's approach to investing: Look for companies with sustainable competitive advantages, whose shares are trading at a discount to their intrinsic value.
Below, five analysts provide a short pitch on a top personal stock holding:
"Autodesk is one of the top holdings in my personal account. The company's stock is more fairly valued now than when I first bought it in early 2009, but the company's appealing growth prospects, extremely entrenched competitive positioning, and robust free cash flow margin--north of 20%--justify its forward price/earnings multiple, which is greater than 20 times. Autodesk's software is ubiquitous in the world of digital design, considering its client base of more than 9 million CAD (computer aided design) users, making it very tough for competitors to displace. Think of the tremendous switching costs required to install, learn, and train users on a new program, in addition to paying a hefty upfront fee. It is also standard software used to educate future engineers and designers, and a program that allows sharing digital designs between designers, manufacturers and suppliers. This creates an enormous network effect. Education facilities train students on Autodesk's software, who in turn seek employers who utilize it, who are motivated to use it because of its de facto industry standard status. A massive installed base provides Autodesk with sizable recurring revenue, and the company's continuing upgrades and add-ons sustain its subscription fees. While there are a few secular headwinds, mainly continuing weakness in U.S. commercial real estate construction, the company has virtually untapped growth opportunities overseas, particularly in emerging markets. This should support double-digit revenue growth over the next decade, and with high-margin maintenance revenue accounting for a greater portion of total revenue, Autodesk's profitability should continue to improve. With earnings growing in the high teens to low 20s for the foreseeable future, I think ADSK stock still offers excellent upside"
"I think Exelon is a great investment both for its business model and for its current valuation. Exelon's wide moat is due to the fact that the firm has the largest nuclear power plant fleet in the nation. Nuclear power is one of the lowest-cost forms of electricity production, and therefore affords the company higher margins than many of its peers with fossil-fuel plants. Thus, even though Exelon's revenue is highly dependent on the fluctuating prices of natural gas and coal, the company's consistently low cost base is a valuable competitive advantage, in my view. In addition, nuclear plants are much cleaner--an increasingly important factor given likely stricter future environmental regulation. Lastly, it takes a very long time to set up a new nuclear plant, which means that Exelon's nuclear leadership is not about to go away anytime soon. Regardless of the type of the energy source, electricity is arguably one of the best defensive commodities. Even though competition and regulation can be quite fierce at times, demand for electric power is always present through economic booms and busts.
Exelon's valuation is also very attractive. Trading at a forward P/E of less than 10x and an EV/EBITDA multiple of less than 5.5x gives this moaty stock a healthy upside, in my opinion. Additionally, its dividend is quite juicy and, more importantly, it is sustainable. Thus, while patiently waiting for capital gains, I think the investor gets a fine 5.3% yield."
MasterCard is trading for less than 15 times consensus earnings-per-share estimates for next year. I think that is a very reasonable valuation for a company with a wide economic moat and tremendous growth potential. MasterCard's business model is a thing of beauty. The company earns revenue in two primary ways: by processing financial transactions (acting as an intermediary between banks) and by charging assessments based on the dollar volume of activity on cards carrying the MasterCard brand. I view the company as basically a toll collector on global economic activity. Its revenue represents just 0.2% of the "gross dollar volume" of activity on MasterCard's credit, debit, and prepaid cards. In my opinion, it is reasonable to expect that revenue will grow at least as fast as global gross domestic product for the foreseeable future. Revenue should grow even faster as card-based payments increasingly replace paper-based forms of payment. MasterCard processes more of the transactions on its cards, so increased globalization leads to more higher-revenue cross-border transactions, and so on. Since MasterCard's costs are largely fixed, and the company's very low capital requirements leave lots of cash available for share repurchases, I think earnings per share could grow in the double-digits for a long time to come. I tend to prefer MasterCard over Visa (V) because it has a greater concentration of faster-growing international business, is trading for a lower P/E multiple, and has greater room for upside due to its lower current market share and operating margin. The greatest risk for MasterCard is regulatory, but I think recent concerns about regulation of interchange fees in the U.S. have been overblown, and the new rules will have relatively little impact on MasterCard."
"One of the top holdings in my personal account is Fair Isaac. The firm has built itself into an integral part of the consumer credit and borrowing process through its FICO score product. Whenever a consumer applies for a retail credit product, chances are good a FICO score is used to gauge the creditworthiness of the applicant. Fair Isaac developed the algorithm which is the guts of a FICO score back in the 1950s, and it has served as the standard used by most lending institutions ever since. The firm took its dominant market position and built itself a narrow economic moat, thereby producing stellar ROICs. However, over the last few years Fair Isaac has faced some harsh headwinds which caused its stock price to tumble 70% between January 2007 and March 2009. The credit crunch of the last few years (lower demand for credit checks due to lower borrowing demand) and the advent of the VantageScore credit scoring product (a FICO-like score being offered by the three major credit bureaus) have given many investors great concern over Fair Isaac's future operating environment.
Although Fair Isaac's revenue has reset to a lower level, and credit demand will increase at only a modest rate going forward, the current pressure on the company's results will abate, in my opinion. As the economy recovers and consumer credit activity bounces from trough levels, the demand for FICO scores will increase. Although demand will certainly not hit prerecessionary levels, I believe it will be strong enough for Fair Isaac's core business to thrive. Additionally, concerns that the firm's scoring business is being threatened by competing product VantageScore are overblown. The FICO score has been long-established, and has proven itself to be a reliable and effective means of managing credit risk for institutions over the years. This leaves lenders with little motivation to switch to an unproven product like VantageScore. A low capital investment rate, scalable business, sticky client base, and dominant market position should allow Fair Isaac to continue to produce excellent results."
Bradley Meeks � Equity Analyst, Business Services
Top Personal Holding: Standex International (SXI)
Morningstar Rating: Not Covered
"Standex International is a diversified manufacturing company that produces a variety of products and services globally. The firm does everything from manufacturing food service equipment and hydraulic lifts to engraving plastics and creating electrical components for airplanes. Standex has a market cap of only $380 million, with little analyst coverage, allowing it to fly under the radar of most on the street. The firm is trading at a forward P/E of 11 times 2012 estimates, and has traded close to 15 times over the past five years. The firm generates solid free cash flow, and has made impressive steps towards lowering its balance sheet risk by aggressively paying down debt. In fact, net debt to capital has come down from 33% in 2009 to 24% in 2010. Standex pays a modest dividend, which yields roughly 1%, and has paid it for over 44 years. The company's revenue base is fairly diversified, and relatively insulated from the gyrations of the macroeconomic environment, but is susceptible to weaknesses in several of its end markets (housing in the air distribution business for instance). However, other business lines, like the Electronics division, are rebounding strongly as demand from China increases, and as the unit grows its market share. The company has cut roughly $40 million in costs over the past 18 months, which should position it nicely to benefit from favorable operating leverage, as many of its end user markets stabilize and sales gradually increase. Assuming only modest single digit top-line and earnings growth still provides a nice upside due to the newly rationalized cost structure and fairly low reinvestment needs."
Matthew Coffina has a position in the following securities mentioned above: EXC, MA. Find out about Morningstar’s editorial policies.