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Market Update

6 Stocks Top Managers Have Been Buying

Managers from Oakmark, Dodge & Cox, and BBH picked up healthcare names, telecoms, and a hotelier among others last quarter.

Ordinary investors like us can find investing ideas in a variety of places. Sometimes, websites like this one shine the light on stocks that appear undervalued by some set of metrics. Other times, a trusted advisor or colleague may give us the name of an investment to explore further.

But every once in a while, we can get ideas from extraordinary investors.

At Morningstar, we like watching what stocks our Medalist managers bought the previous quarter. After all, Morningstar knows who the best money managers are; why not tap into their expertise when seeking new stock ideas?

Here are a half dozen stocks that highly rated large-cap fund managers have been buying.

Bill Nygren and Kevin Grant, who skipper Gold-rated Oakmark (OAKMX), practice a value strategy that focuses on companies with solid balance sheets run by smart management teams who make wily capital allocation decisions--and whose stocks are trading at deep discounts to Nygren and Grant’s assessment of private-market value.

During the second quarter, the duo added Bristol-Myers Squibb (BMY), Hilton Worldwide Holdings (HLT), and Gartner (IT) to the portfolio.

Bristol is no stranger to Oakmark's portfolio: The team sold a profitable position in the stock back in 2013.

"We got another opportunity to own this company during the past quarter when investors became fearful that a competing drug would take share in the cancer market," they note in their latest commentary. "We believe these fears are overstated because cancer remains a dangerous disease that is difficult to treat. The company's two most valuable drugs Opdivo and Yervoy should continue to grow revenue as they maintain effectiveness with new tumor types. Bristol Myers Squibb also has the most new molecular agents and the highest number of combinations of agents in trials. Moreover, the company's R&D and marketing prowess also make it a desired partner for promising academic and small biotech innovators. Collectively, these assets should assure Bristol-Myers Squibb's oncology leadership for many years. We believe intrinsic value is closer to the $70 level it traded for earlier this year than its more recent price in the low $50s."

Morningstar pegs Bristol's fair value at $64 with a medium uncertainty rating. That translates to a 3-star rating as of this writing, suggesting that shares are fairly valued today.

Sector director Damien Conover wrote in a late-July note that although the wide-moat drugmaker's second-quarter results were strong, he was surprised by the renal cancer setback that Opdivo suffered in Europe. That led to a slight reduction in his projections, but the firm's fair value estimate and moat rating remain unchanged.

"Overall, the continued progress with strong sales of currently marketed drugs combined with advancements in the pipeline reinforce our wide moat rating for the firm," he concludes.

Nygren and Grant also picked up Hilton Worldwide last quarter. 

"Hilton Worldwide is a high-quality, well-managed company that was the target of a successful leveraged buyout by Blackstone in 2007. We believe the company's transformation into an asset-light, fee-driven business with a more resilient earnings profile is underappreciated. After spinning off most of the company's owned hotels and timeshare businesses early last year, Hilton now generates over 90% of its profits from fees (requiring minimal capital investment) and produces substantial free cash flow (greater than 100% of net income). The company should generate high single-digit operating income growth for several years. We became interested in Hilton after we determined that its competitive moat is widening. The company's unit growth leads the industry and its global pipeline share is almost 22%--over four times larger than its current share of existing rooms (approximately 5%)."

Morningstar agrees that the firm's moat is widening; it assigns Hilton a narrow moat and positive moat trend.

"We see Hilton as well positioned to expand its brand advantage and therefore award the company a positive trend rating," explains senior equity analyst Dan Wasiolek. "Next-generation explorers (generation X and younger) are beginning to enter their peak earning years (currently 70% of the U.S. working population, growing to near 90% in 10 years, according to Marriott) and now outnumber baby boomers at an increasing rate (by 2030 will represent 78 million travelers, 18 million more than baby boomers, according to hospitality consulting firm HVS), so gaining their trust and loyalty now should continue to pay dividends for decades to come. The growing millennial demographic seeks local experiences in the places they are visiting, and as a result we believe brands focused on select service (less desire to dine in full-service hotels that may also have higher-priced rooms) and lifestyle (offer the feel of the locale) are better positioned for this growing traveler base. Hilton has solid exposure to select service (around 40% of total existing rooms) via its Hampton, Hilton Garden, and more recent launches Curio, Canopy, Tru, and Tapestry Collection (which also address the lifestyle segment and we believe are currently around high single digits of the total pipeline)."

According to Morningstar's metrics, Hilton is fairly valued, trading in 3-star range.

Oakmark's last pickup is Gartner, the world's leading provider of information technology research and advice for information technology executives.

"Gartner is the Consumer Reports of the information technology industry," say Nygren and Grant. "However, while the Gartner brand has been among the most recognizable in information technology research for more than 35 years, most sizable enterprises are still not Gartner subscribers. The company is investing heavily in sales and marketing to grow its customer base and based on the excellent long-term track record of Gartner management, we believe these investments are likely to drive years of double-digit growth. While the company trades at a high multiple of GAAP earnings, that multiple falls significantly after adjusting sales and marketing expenses to account for the multi-year life of new customers. On our adjusted earnings estimates, Gartner’s price-to-earnings ratio is in line with the S&P 500. We believe this is a bargain price for a high-return, high-growth business with an excellent management team."

Morningstar analysts don't currently follow Gartner. However, according to our quantitative equity ratings, the stock is fairly valued today.

At Silver-rated BBH Core Select  manager Michael Keller and his team maintain a concentrated portfolio of profitable cash generators with strong balance sheets that are trading at least 25% below their estimate of intrinsic value. They initiated a new position in Allegion (ALLE) during the second quarter. Allegion is a global security company with a portfolio of leading brands. Keller believes the markets in which Allegion competes and intends to address are large and likely to grow.

"We believe that Allegion's large installed base of existing products in the markets it serves, together with innovative new product offerings and strong operational and capital execution on the part of management will allow the company to maintain robust operating margins and returns on capital," he notes in his latest commentary. "The durability of compounding growth at relatively high rates of economic margin is the most significant element of our differing investment perspective and is the key driver of the upside opportunity we see in our estimate of Allegion’s intrinsic value per share relative to the current market price."

Morningstar assigns Allegion a wide economic moat and a stable moat trend. It's undervalued today, trading in 4-star range.

"Allegion's strong operating margins have been remarkably stable throughout the business cycle," notes analyst Brian Bernard in his latest company report. "Despite competition from formidable competitors, Allegion has consistently capitalized on its brand equity, strong distribution network, and large installed base to drive excess returns. Since the company's 2013 spin-off from Ingersoll-Rand, we estimate the firm has generated an average return on invested capital of about 22%, well above its weighted average cost of capital. We believe Allegion is well positioned to maintain its competitive advantages within the Americas business over the next 20 years. As such, we award Allegion a wide economic moat, supported by the firm’s intangible assets and customer switching costs."

Lastly, the team at Gold-rated  Dodge & Cox Stock (DODGX) look for stocks that are cheap on a range of valuation metrics, allowing bottom-up, fundamental research to drive its stock selection. The team has been known to take advantage of bad news to buy fundamentally strong businesses. It recently picked up additional shares of Comcast (CMCSA) and Charter Communications (CHTR).

"The media landscape is evolving due to direct-to-consumer new entrants, changes in consumer viewing and listening habits, shifting revenue streams, and industry consolidation," they explain in their latest commentary. "Uncertainty surrounding pending M&A transactions and potential regulatory incursions (e.g., unbundling, forcing wholesale access, price regulation on broadband) pose risks to the Fund's media investments. Nevertheless, we recently added to Comcast and Charter Communications--the largest and second-largest U.S. cable providers—because we believe the market has overly penalized their share prices as a result of concerns about subscriber growth and potential bidding wars. Both companies have attractive valuations, difficult to replicate assets, and the potential to benefit from growth in data consumption. Comcast and Charter Communications also have de-facto local monopolies on broadband internet services in many parts of the United States, and despite talk of "cord cutting," both have potential to grow through increased broadband penetration and pricing power in residential and business services. Furthermore, their shareholder-friendly management teams are skilled capital allocators who seek to maximize value."

Morningstar awards Comcast a wide moat and a stable moat trend. It's currently trading in 4-star range, suggesting shares are undervalued.

"Of the old guard, we believe Comcast is the best-positioned U.S. communications firm," argues equity analyst Neil Macker. "Irrespective of the challenges faced by traditional pay TV, broadband demand continues to accelerate. We believe Comcast is better situated to benefit from this trend due to its faster Internet speeds than many of its telco peers. We assign Comcast a wide economic moat rating based on cost advantage and efficient scale inherent in its residential broadband business and cost advantage inherent in its business services segment. We expect these advantages will enable the firm to generate excess returns on capital, more likely than not, over the next 20 years."

Morningstar analysts don’t currently follow Charter Communications. However, according to our quantitative ratings, the stock is significantly undervalued today.

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