(By
Jeremy Glaser) The
S&P 500 hit a five-year high this week after posting an impressive
run of 16% in 2012 and then tacking on another 3.3% so far in 2013.
Although there has been plenty of volatility, stocks have mostly
shrugged off U.S. fiscal concerns, the eurozone crisis, and the
emerging-markets slowdown. It isn't that investors have been ignoring
these issues; it's that corporate fundamentals have looked fairly solid
during the last few years.
But now stock prices seem to have fully caught up with fundamentals.
The median price/fair value of all stocks rated by Morningstar's equity
research team now stands at 1.00.
That is to say, the median company is now trading at exactly what our
analysts estimate the firm's intrinsic value is. One year ago that ratio
stood at 0.90. A fully valued market, combined with today's heightened
levels of policy and economic uncertainty, creates an unsettling
environment for stock investors. Morningstar head of global equity and
credit research Heather Brilliant stated recently that "market volatility will be a way of life in 2013" and that long-term investors will once again have to focus on security selection in order to outperform.
Investors looking to have a somewhat smoother ride through 2013 might
want to take a close look at Morningstar's fair value uncertainty
ratings for individual stocks. Analysts not only peg what they think a
company is worth, they also put a rating on how wide the potential range
of outcomes is for that firm. Companies with low uncertainty ratings
are ones that the analyst feels confident about the future path of the
business, that generally have solid financial strength, and that are
likely to stay the course regardless of macroeconomic concerns. These
firms still will likely see a fair deal of volatility, but we'd expect it to be less extreme than that of the broader market.
We used the Premium stock screener
to find firms that look undervalued (ones that have Morningstar Ratings
for stocks of 4 or 5 stars) and that have low uncertainty ratings. Here
are three names that passed the screen for your radar. You can run the
screen for yourself by 
.
American Electric Power (AEP)
| Economic Moat: Narrow
From the Premium Analyst Report:
American Electric Power, long the stalwart regulated utility providing
consistent earnings growth and dividend payments, faces a business
transformation that could change its earnings and dividend growth
profile. AEP generates 95% of its earnings from its regulated operations
now. However, as Ohio transitions toward deregulation, the company will
reposition assets, and could reduce generation to just 65% of its 2012
level. We forecast approximately 20% of revenue will come from
competitive operations in 2016, exposing AEP to volatile power, coal,
and natural gas commodity markets.
Costco Wholesale (COST)
| Economic Moat: Narrow
From the Premium Analyst Report:
Costco offers investors the highest near-term cash flow visibility in
our defensive coverage sector. The company books nearly all its profits
12 months in advance. Membership revenue, although deferred over the
life of the annual membership, is paid at the beginning and accounts for
nearly all of Costco's operating profits. Furthermore, even after fee
increases and in recessions, member renewal rates have remained steady
around the 86% level. Costco cardholders renewed their memberships at an
86% rate during and after the Great Recession. Therefore, we have a
very high level of certainty in our near-term financial forecast.
Moreover, cash, a debit card, or an American Express (AXP)
charge card are the only forms of payment accepted at Costco. In our
view, this indicates a high credit quality customer base, which we
believe can better withstand economic downturns. For these reasons, as
well as being free cash-flow positive and in a net cash position, Costco
trades at premium valuation to nearly all of the other companies in our
defensive space.
Novartis (NVS)
| Economic Moat: Wide
From the Premium Analyst Report:
In an industry plagued by stagnant growth, Novartis is well-positioned
with diversified operating platforms and an industry-leading number of
new potential blockbuster drugs. Strong intellectual property supporting
multi-billion-dollar products, combined with an abundance of late
pipeline products, creates a wide economic moat. While the 2012 patent
loss on Diovan and manufacturing problems in the consumer division will
weigh on near-term growth, the company's strong strategic position
should lead to steady long-term growth.