Morningstar Advisor - June/July 2013 - (Page 69)

Screens Let’s Get Back to Basics By John Zecy Basic materials companies are among the cheapest stocks in our coverage universe. In recent analysis of the price/fair value ratios of Morningstar’s stock coverage universe, we observed that basic materials companies offer some of the steepest discounts to our fair value estimates. As such, we ran a detailed stock screen to find attractively priced basic materials names with durable competitive advantages that could boost an investor’s portfolio returns. Sector  Basic Materials And ( Economic Moat  Narrow Or  Wide Economic Moat Our analysts assign a Morningstar Economic Moat to firms that have been able to generate returns in excess of their cost of capital for a decade or more thanks to their sustainable competitive advantages. Moats are typically ) earned through intangible assets, cost advantages, switching costs, network effects, and efficient scale. In the case of basic materials companies, a sustainable low-cost advantage is the main potential source of an economic moat as firms produce undifferentiated commodities that are in many cases widely fungible. Specifically within resource extraction, favorable geological characteristics are the most important determinants of costs. When considering a company’s future cost position, we incorporate all relevant outlays including: lease and permit costs, all payments to service and equipment providers, development expenditures, production expenses, and royalties. And PCF  12 While a firm may carry sustainable competitive advantages, we want to ensure that we are paying a reasonable valuation. Consequently, we set the cutoff at companies trading at less than 12 times their current price/cash flow. And Morningstar Rating > 4 To expand on our valuation screen, we used the Morningstar Rating for stocks and searched for companies with at least a 4-star rating. A number of components drive this score, including our assessment of the firm’s economic moat, our estimate of the stock’s intrinsic value based on a discounted cash-flow model, the margin of safety bands we apply to our fair value estimate, and the current stock price relative to our fair value estimate. MorningstarAdvisor.com 69 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2013

Morningstar Advisor - June/July 2013
Contents
Contributors
Letter From the Editor
Not Your Values
How Do You Use Alternatives for Clients?
Working to Build a Niche
How to Put Buffett’s Investing Philosophy into Practice
Sophisticated Strategies for the Masses
Investments á la Carte
Investment Briefs
The Percentile Trap
Defense Firms Will Stay Aloft
Beware the Lure of Diversification
Using Alternatives in Practice
Managed Futures and Cash Rates
The World Is Getting Grayer
Waiting to Pull Up Anchor
The Price of Managing Volatility
Let’s Get Back to Basics
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Mutual Fund Urban Myths

Morningstar Advisor - June/July 2013