Companies that Make the Grade

It's tough to excel in everything. Just as the same people who get A's in English literature don't often outshine in physics and math, it's rare to find companies that get topnotch grades in a variety of areas. A company might pursue growth at the expense of profitability (think  AOL Time Warner ), or sacrifice a little growth for better financial health (think  Novartis (NVS), which has historically had sluggish growth but a pristine balance sheet).

For this week's Five-Star Investor, we'll focus on companies with topnotch Morningstar grades in three areas: growth, profitability, and financial health. Our stock grades are based on the company's underlying financial statements. They take into account both the strength of the company relative to other companies in the same sector, as well as recent trends in financial performance.  

To start, we used Morningstar's  Premium Stock Screener to find companies that earn grades of A or better in all three areas. Although the focus of this screen is finding outstanding companies (rather than cheap stocks), we did add one additional hurdle to weed out companies with current P/Es above their historical averages. 

As always, we'd advise investors to use this as a starting point, not a buy list. Only one of the stocks that passed (perennial favorite General Dynamics) currently trades at a significant discount to Morningstar's fair value estimate. Several of the other stocks on the list ( Forest Laboratories  and  Nokia (NOK), for example) are pretty pricey in absolute terms, but could be worth scooping up if their valuations dipped lower.

Here are some highlights.

 General Dynamics  (GD)
Economic Moat: Wide
Business Risk: Average
Morningstar Rating: 5 Stars
From the  Analyst Report: "Although results at its Gulfstream unit may remain turbulent for a while, General Dynamics remains our favorite aerospace and defense manufacturer. What's more, we see the shares as attractively priced."

 Capital One Financial  (COF)
Economic Moat: Wide
Business Risk: Above Average
Morningstar Rating: 3 Stars
From the  Analyst Report: "Most high-flying lenders that blew up impressed investors with their credit skills at one time. Capital One has never been tested in a severe consumer downturn. There's an unknown risk with every loan portfolio, especially one that's grown fast and includes subprime credits. But given its credit-line management, charge-off rates, reserving methodology, and revenue-recognition policies, we think management is conservative. And we think the business model is profitable enough and flexible enough to bend with the times. On a managed basis over the past five years, for example, Capital One generated on average an 18% return on invested capital, well above its cost of capital."

 Cheesecake Factory (CAKE)
Economic Moat: None
Business Risk: Average
Morningstar Rating: 3 Stars
From the  Analyst Report: "We still think Cheesecake has a lot of room to expand its restaurants, and a hiccup in the growth plans could lead to a buying opportunity for the shares. The telltale signs of continued growth remain in place: The company plans to open 14 additional units in 2003, and same-store sales at its second restaurant concept, Grand Lux Cafe, surged 10% in the first quarter from the prior-year period. However, if first-quarter results were really an early sign of trouble, our estimates could change. For example, Cheesecake's frequent menu-price increases in combination with a difficult economy might convince its patrons to dine elsewhere."

 Equity Office Properties Trust  
Economic Moat: Narrow
Business Risk: Below Average
Morningstar Rating: 3 Stars
From the  Analyst Report: "Equity Office Properties faces a difficult leasing environment that may get worse before it gets better, but this blue-chip real estate investment trust (REIT) should safely weather the current economic storm. Our net asset value is $27 per share."

Click  here to run this screen yourself and see all the stocks that passed. (Note: You will need to be a Premium Member to view and save the complete screen.) After clicking, you can save the screening criteria by using the "Save Criteria" button in the bottom right-hand corner of the screen.