Stocks That Give You Peace of Mind

The last decade of returns has burned into investors' minds the fact that stocks are volatile. Huge swings from the end of the tech boom to the highs of the mortgage bubble to the depths of the financial crisis sent account balances alternatively zooming and crashing.

And even though volatility has calmed considerably in the last year, no one believes it is gone forever. During the next 10 years there is a strong possibility that we will see another recession and more sell-offs and recoveries.

Many investors' reaction to this head-spinning has been to eschew equities altogether. Fund flows into bond funds have been massive while stock funds have seen money rush for the door. The sentiment is understandable but many people, especially those with long time horizons, are selling themselves short. Even conservative investors can help improve their risk/reward balance by allocating a slug of money to stocks.

This is particularly true now considering the headwinds that fixed income will face in the coming years. As Morningstar's Ryan Leggio points out, much of the return in fixed income recently has been from capital appreciation caused by declining interest rates and inflation. Rates have nowhere to go but up, and inflation is also likely to pick up. These factors will drive down total returns for the foreseeable future.

But how should skittish investors add equity exposure without losing too much sleep? We think the answer is to look for stocks with wide economic moats. These firms have strong, sustainable competitive advantages over their rivals which allow them to perform in good times and bad. Certainly wide moat firms' earnings are still tied to the economic cycle, but we'd expect them to hold up better than a firm that can't keep its competition at bay.

Wide-moat firms can also act as a good hedge against another worry: inflation. A competitive advantage often means that a firm is able to dictate prices. As the general price level rises, wide-moat firms should be able to pass its higher costs to consumers in the form of higher prices. In more competitive industries, firms often end up with lower profit margins in inflationary environments because they aren't able to charge higher prices.

A low fair value uncertainty rating can also ease fears. The rating means that Morningstar's stock analysts believe the range of outcomes for the stock is relatively narrow. This implies the business is very steady and predictable, something that should help tamp down on stock-price volatility.

So can investors just buy wide-moat, low-uncertainty stocks, forget about them, and not worry? Absolutely not. Less volatile doesn't mean there still isn't quite a bit of volatility in these stocks. And you need to check in with your holdings occasionally and make sure that your investment thesis still holds. Moats can erode over time as new competitive threats emerge over the years. Furthermore, don't forget about valuation. Paying too much, even for the best companies, is a recipe for disaster.

We used Morningstar's  Premium Stock Screener to find some of these cheap gems. We screened for wide-moat, low-uncertainty firms rated either 4 or 5 stars. Here are four names that passed. Run the screen for  yourself here.

 Colgate-Palmolive Company (CL)
| Projected Yield: 2.71%
From the  Premium Analyst Report:
Colgate-Palmolive has long been one of the most focused consumer products companies on the planet, dominating the oral-care category with a worldwide toothpaste market share of almost 45%. The firm's expertise extends beyond toothpaste, however, as it operates with some of the most sophisticated promotional tools in its industry. Capabilities in products and processes give Colgate a wide-moat advantage and enviable returns on invested capital.

 Medtronic (MDT)
| Projected Yield: 2.63%
From the  Premium Analyst Report:
With its diversified portfolio and strategy to develop products for a wide range of chronic diseases, Medtronic is well-positioned to take advantage of new trends in disease management.

This wide-moat company's vision is to establish a significant presence in chronic diseases, in addition to its historical stronghold in heart disease. Investments in neuromodulation, diabetes, and spinal products from the middle to late 1990s have paid off in spades, offering new revenue streams and taking some pressure off heart products. Revenue from those three product areas increased from 25% of total sales in fiscal 2000 to 40% in fiscal 2010. Medtronic's diversified medical technology portfolio allows it to better weather glitches in the development or approval process for any particular new device.

 PepsiCo (PEP)
| Projected Yield: 2.97%
From the  Premium Analyst Report:
We assign a wide economic moat to PepsiCo because of its economies of scale, its dominance in the snack category, and its effective distribution network. The direct-store-delivery system allows the firm to leverage its impressive portfolio of brands and should ensure that PepsiCo maintains its strong returns on invested capital over the long run.

 3M (MMM)
| Projected Yield: 2.49%
From the  Premium Analyst Report:
Over its long history, 3M has invented some of the world's greatest products. We think that the firm's innovative culture, bottom-line focus, and low-cost manufacturing have carved a wide moat around its business that will enable the company to reap outsized rewards over the long run.

Data as of Dec. 7, 2010.