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StockInvestor
April 2009

Volume 8
Number 10

Buying core holdings at a discount

Moats: The Only Constant
Is Change
This month, I have a sneak-peak of a new stocks
rating that we are in the process of rolling out. But
first, allow me to set the stage.
One of the cornerstones of my strategy in managing
the Tortoise and Hare model portfolios is to focus
on the highest-quality companies, those with wide
Not only do companies go through lifecycles and
continuous change, but the amount of time a company
spends in any given lifecycle stage varies greatly.
Some companies can go through all four stages inside Paul Larson
of a decade (think AOL), while others can enjoy stable Equities Strategist and Editor
advantages that allow them to enjoy maturity and
robust cash flow for generations (think Coca-Cola KO).
The Tortoise Portfolio 2
Every company is unique, and there are no standard Our favorite wide-moat firms
actuary tables when considering a moats duration. with lower risk, including
Berkshire Hathaway and Diageo
To illustrate how a companys moat can change over
The Hare Portfolio 4
time, simply roll back the clock a couple of decades. Our favorite aggressive picks
General Motors GM back in the 1950s and 60s had a with moats, including MasterCard
market share in the U.S. of just under 50% and and Enterprise GP Holdings

economic moats. We define a moat qualitatively enjoyed the economies of scale the share enabled.
Tortoise and Hare Focus 6
by looking for sustainable competitive advantages such Today, after a combination of poor execution and Lowes, TransCanada, Magellan
as high customer-switching costs, the network effect, the accumulation of decades worth of labor liabilities, Midstream Partners, Stryker
intangible assets, and so on. We can also confirm a GM is on life support from the government. AT&T T
Economic Weather Report 10
moat is present quantitatively by looking at a companys back in the day had such a large moat that the govern- A look at the money supply
economic profitslooking for returns on invested ment saw fit to break it up. Nowadays, the rele-
capital higher than a companys cost of capital. In order vance of fixed line telephones is rapidly dwindling to Bulls vs Bears 12
General Electric
for a company to attain a wide moat rating, we gener- near nil. Eastman Kodak EK once had a great
ally expect a firm to have advantages large enough to brand and an attractive razor and blades model. That Wide-Moat Watchlist 14
sustain positive economic profits for 20 years or longer. is, until digital cameras came around. Finally, news- Ratings and comments on more
papers once had a stranglehold on information flow in than 165 wide-moat companies

Moats are not static things; they are dynamic and any given city, until alternative media types ate into
Spotlights 22
constantly evolving. (Thanks to the Greek philoso- their market share. Deeper looks at eBay and
pher Heraclitus for this months title.) All businesses consumer products firms
go through a life cyclestartup, growth, maturity, Of course, not all companies are going to achieve the
Healthcare Observer 26
declineand a companys competitive advantages same dramatic demise as these salient examples, Medical information technology
tend to change over time as the underlying busi- but the point is that all moats are always under siege.
nesses age. This change depends on where in its life- Attracted by the high returns on capital a moat- OptionInvestor 27
Johnson & Johnson Calls
cycle its businesses are as well as the technolog- protected business allows, competitors are constantly
ical and economic environment. The sands of time are trying to breach moats to get a piece of the pie for Stocks to Sell 28
always affecting companies, usually eroding existing themselves. Moreover, companies can get complacent CMS Energy and Spectra
moats and clicking years off any given companys because of their success. Firms also might reinvest Energy Partners

advantage period. significant amounts of capital outside their moats in

less attractive businesses, diluting the moatiness
Continued on Page 30
Ports_0409.qxp 4/7/09 4:27 PM Page 2

The Tortoise Portfolio
Morningstar Stock Portfolios | Paul Larson
From inception on June 18, 2001, through April 3,
2009, the Tortoise has returned positive 37.8%
compared with a negative 19.7% for the S&P 500
Index and negative 16.6% for the average large-cap
blend mutual fund. The Tortoise has outperformed
99.5% of large-cap blend funds since inception and
96.4% of these funds over the past 12 months.
I made no trades in the portfolio this past month, but
there was certainly plenty of action in the markets.
After reaching a low on March 6, the markets made a
historic bounce, with the S&P 500 rising more than
25% in roughly four weeks. The Tortoise certainly
participated in the rally, with the 17.1% increase in
value since last issue marking a new all-time high in
terms of monthly performance. To put this in perspec-
tive, the Tortoise has only had one other month where
it rose a double-digit percentageOctober 2002,
when it was up 14.8%.
The lift was widespread, with every single stock in
the Tortoise rising in price by at least 5%. There was

The Tortoise Portfolio Holdings Morningstar Ratings & Fundamentals

Portfolio Star Fair Value Fair Current Consider Consider Size of Dividend
1
Performance Stock Name Rating Uncert. Value ($) Price ($) Buying Selling Moat Yield (%) Stewardship

and Transaction Berkshire Hathaway BRK.B QQQQQ Med. 4600.00 3004.00 3220.00 6440.00 Wide
Summary
Kinder Morgan Mgmt KMR QQQQQ Low 70.00 41.43 56.00 87.50 Wide 8.7
5 Shares added First American FAF QQQQ High 40.00 27.85 20.00 80.00 Narrow 3.2
5 Shares sold Wal-Mart Stores WMT QQQQ Low 60.00 53.80 48.00 75.00 Wide 1.8
C 5 New holding
Lowes Companies LOW QQQQQ Med. 36.00 19.12 25.20 50.40 Wide 1.8
NR 5 Not Rated
UR 5 Under Review Novartis NVS QQQQQ Low 73.00 37.51 58.40 91.30 Wide 4.6
Johnson & Johnson JNJ QQQQQ Low 80.00 52.15 64.00 100.00 Wide 3.5
Goal of the Tortoise
The Tortoise Portfolio has two Automatic Data Processing ADP QQQQQ Med. 58.00 36.67 40.60 81.20 Wide 3.4
goals: to outperform the Walgreen WAG QQQQ Med. 38.00 26.91 26.60 53.20 Narrow 1.6
S&P 500 Index and to generate ExxonMobil XOM QQQQQ Low 87.00 70.44 69.60 108.80 Wide 2.3
positive returns regardless of
the broad market environment. Sysco SYY QQQQQ Med. 35.00 22.93 24.50 49.00 Wide 4.0
Companies in this portfolio Cintas CTAS QQQQ Med. 35.00 25.59 24.50 49.00 Wide 1.8
tend to be large, moderate to General Dynamics GD QQQQQ Med. 65.00 42.66 45.50 91.00 Wide 3.3
low risk, and slow growing.
Coca-Cola KO QQQQ Low 55.00 44.97 44.00 68.80 Wide 3.5
We aim for all the companies
here to have an economic moat. J.P. Morgan Chase & Co. JPM QQQ Ext. 41.00 29.28 Narrow 4.1

PepsiCo PEP QQQQQ Low 71.00 52.69 56.80 88.80 Wide 3.2
Home Depot HD QQQQ Med. 35.00 25.00 24.50 49.00 Wide 3.6
TransCanada TRP QQQQQ Med. 38.00 24.60 26.60 53.20 Narrow 4.4
Diageo DEO QQQQQ Med. 80.00 47.24 56.00 112.00 Wide 4.8
3M Company MMM QQQQQ Low 85.00 52.11 68.00 106.30 Wide 3.9

Bank of America BAC QQQ Ext. 16.00 7.60 Narrow

Pfizer PFE QQQQQ Med. 26.00 13.55 18.20 36.40 Wide 9.5
American Express AXP QQQQQ V.High 54.00 15.33 21.60 135.00 Wide 4.7
Moodys MCO QQQQ High 33.00 23.54 16.50 66.00 Wide 1.7

Cash Holdings
Tortoise Portfolio Total 3.5
Ports_0409.qxp 4/7/09 4:27 PM Page 3

Morningstar StockInvestor April 2009 3

Median Price/Fair Value Ratio also a massive move in a handful of stocks. In gen- event could stop this recovery in its tracks. But Im
Subgroup Med. P/FV Ratio eral, the more punished the stock during the earlier hopeful that we have indeed turned a corner.
All Stocks 0.82 parts of this crisis, the greater the bounce. Just since Contact Paul Larson at paul_larson@morningstar.com
Wide Moat 0.71
last issue, Bank of America BAC rose 112%, J.P. Paul Larson personally owns shares of the following Tortoise stocks:
Narrow Moat 0.79
Morgan Chase JPM was up 52%, Moodys MCO was AXP, BAC, BRK.B, CTAS, DEO, FAF, GD, HD, JNJ, JPM, KMR, KO, LOW,
No Moat 0.88
MMM, NVS, PFE, SYY, TRP+, WAG, WMT, and XOM.
Low Uncertainty 0.77 up 40%, and Lowes LOW increased 35%.
Medium Uncertainty 0.78 1 5 Paul has added to his position in the stock in the past month.
High Uncertainty 0.83 2 5 Paul has reduced his position in the stock in the past month.

NYSE 0.81
I have no idea if this bounce will stick or if it is merely
2009 Morningstar, Inc. All rights reserved. Any opinions, recommendations,
NASDAQ 0.85 a bear market rally, but I do know that when there or information contained herein: (i) is for educational purposes only; (ii) is not

Data through April 3, 2009.

is a changing of the guards from bear market to bull
market, it usually does so with a tenacity like we just
experienced. Also, for the first time in a long time,
some of the economic indicators are not horrible. The
seeds of recovery are very sensitive, and a negative
guaranteed to be accurate, complete, or timely; (iii) has not been tailored to suit
any particular persons portfolio or holdings; and (iv) should not be construed
as investment advice of any kind. Neither Morningstar nor any of its agents shall
have any liability with respect to such opinions, recommendations, or information.
Morningstar has not given its consent to be deemed an expert under the
federal Securities Act of 1933. Past performance is no guarantee of future results.
Before making any investment, consult with your financial advisor. Morningstar
employees may have holdings in the stocks recommended.

Portfolio Transactions Portfolio Value Portfolio Performance Breakdown

Date of First # of Shares Cost Basis/ Total Current % Gain / % of Index This Since5
2 2
Ticker Purchase +/ Change Total Share ($) Cost ($) Value ($) Loss Portfolio Trailing Return (%) Level Month * 12 Month Inception

BRK.B 06-18-01 0 5 2561.60 12807.98 15020.00 17.3 11.5 Tortoise Portfolio 17.1 -27.1 4.2
KMR 03-08-06 0 213 39.41 8394.56 8824.59 5.1 6.8 S&P 500 Index 842.5 18.4 -36.8 -2.8
FAF 03-17-04 0 300 28.70 8610.99 8355.00 -3.0 6.4 NASDAQ Composite 1621.9 19.9 -30.7 -0.5
WMT 07-19-02 0 150 47.43 7114.28 8070.00 13.4 6.2
LOW 11-15-07 0 400 24.70 9878.40 7648.00 -22.6 5.9 % Total Return

NVS 02-09-07 0 185 56.80 10508.61 6939.35 -34.0 5.3 pTortoise Portfolio p S&P 500 Index

JNJ 12-06-05 0 130 59.51 7736.38 6779.50 -12.4 5.2 70

ADP 06-14-02 0 175 27.84 4872.72 6417.25 31.7 4.9

35
WAG 10-11-07 0 230 39.37 9054.92 6189.30 -31.7 4.7
0
XOM 07-11-08 0 80 86.07 6885.99 5635.20 -18.2 4.3
2001 2002 2003 2004 2005 2006 2006 2008
SYY 04-28-08 0 235 29.01 6817.73 5388.55 -21.0 4.1
CTAS 05-16-07 0 200 37.61 7522.00 5118.00 -32.0 3.9 Top Five Sectors (%) Style Breakdown (%)
GD 03-12-03 0 110 33.12 3643.34 4692.60 28.8 3.6
a Financial Srvcs 24.8 Value Blend Growth
KO 10-01-04 0 100 40.63 4062.86 4497.00 10.7 3.4 p50 100
o Consumer Srvcs 24.3 26 37 18 Lrg
JPM 07-23-02 0 150 30.49 4574.16 4392.00 -4.0 3.4 p25 50
f Energy 14.2 13 5 0 Med p10 25
PEP 07-19-02 0 75 35.92 2694.25 3951.75 46.7 3.0 i Healthcare 12.3
0 0 0 Sm
p0 10
HD 09-24-01 0 150 21.85 3277.50 3750.00 14.4 2.9 p Business Srvcs 9.9
TRP 01-23-04 0 150 21.21 3181.88 3690.00 16.0 2.8
Morningstar ratings and fundamentals as of 4-3-09. Portfolio inception date: 6-18-01.
DEO 07-17-08 0 60 74.23 4453.59 2834.40 -36.4 2.2
1 4
Dividend yield is based on dividends Includes capital gains.
MMM 01-23-08 0 50 74.93 3746.49 2605.50 -30.5 2.0 paid the past 12 months. 5
Returns since inception are annualized
2
Cost basis includes commissions. and include dividends.
BAC 04-25-07 0 270 50.43 13615.67 2052.00 -84.9 1.6 3
Includes interest and dividends. *March 4 to April 3
PFE 09-24-01 0 150 35.21 5281.01 2032.50 -61.5 1.6
AXP 07-18-01 0 125 29.46 3682.50 1916.25 -48.0 1.5
MCO 12-16-02 0 50 20.80 1039.75 1177.00 13.2 0.9

Cash Holdings 2714.29 2.1

130690.03 100.0
Ports_0409.qxp 4/8/09 10:21 AM Page 4

The Hare Portfolio
Morningstar Stock Portfolios | Paul Larson
From inception on June 18, 2001, through April 3,
2009, the Hare has returned positive 11.1% compared
with a negative 19.7% for the S&P 500 Index and
negative 21.9% for the average large-cap growth
mutual fund. The Hare has outperformed 97.2% of
these mutual funds since inception, and 67.1% of
these funds over the past 12 months.
I made no transactions in the Hare this past month,
but there were plenty of fireworks in the portfolio.
Among the Hares 25 stocks, 14 were up in excess of
20% this past month, including five that rose more
than 40%. The only stocks that fell were Amgen
AMGN, Compass Minerals CMP, and TicketMaster
TKTM. There was no large, material news around
these particular companies, and we even raised our
Compass Minerals fair value estimate slightly.
We did make one meaningful change to our ratings
for Dell DELL when we downgraded the economic
moat rating all the way to none. (We had already
downgraded from wide to narrow last year.)

The Hare Portfolio Holdings Morningstar Ratings & Fundamentals

Portfolio Star Fair Value Fair Current Consider Consider Size of Dividend
Stock Name Rating Uncert. Value ($) Price ($) Buying Selling Moat Yield (%) Stewardship
Performance
and Transaction Compass Minerals Intl CMP QQQQQ Med. 85.00 54.52 59.50 119.00 Wide 2.5
Summary
CarMax KMX QQQQ High 18.00 12.11 9.00 36.00 Narrow
5 Shares added MasterCard MA QQQQ High 233.00 174.05 116.50 466.00 Wide 0.3
5 Shares sold Fastenal FAST QQQ Low 39.00 37.00 31.20 48.80 Wide 1.7
C 5 New holding
Paychex PAYX QQQQQ Med. 51.00 27.34 35.70 71.40 Wide 4.5
NR 5 Not Rated
UR 5 Under Review Magellan Midstrm Hldgs MGG QQQQQ Med. 26.00 17.98 18.20 36.40 Wide 7.6

Goal of the Hare

Vulcan Materials VMC QQQQQ Med. 75.00 48.30 52.50 105.00 Wide 4.1
The Hare Portfolio has two Apollo Group APOL QQQQQ Med. 100.00 68.74 70.00 140.00 Wide
goals: to outperform the S&P Enterprise GP Holdings EPE QQQQQ Med. 50.00 22.71 35.00 70.00 Wide 7.9
500 Index and to generate posi- International Speedway ISCA QQQQQ Med. 51.00 24.74 35.70 71.40 Wide 0.5
tive returns regardless of the
broad market environment.Com- Western Union WU QQQQQ Med. 28.00 13.82 19.60 39.20 Wide 0.3
panies in this portfolio tend to eBay EBAY QQQQQ Med. 24.00 14.31 16.80 33.60 Wide
either be small or fast growing,
Autodesk ADSK QQQQQ Med. 28.00 17.99 19.60 39.20 Wide
or have a high risk/return
proposition. All companies here
Amgen AMGN QQQQ Med. 65.00 46.57 45.50 91.00 Wide
have an economic moat. Discover Financial Svcs DFS QQQQQ V.High 30.00 6.75 12.00 75.00 Narrow 3.0

CEMEX CX QQQ High 7.00 7.47 3.50 14.00 Narrow 11.2

Microsoft MSFT QQQQQ Low 35.00 18.75 28.00 43.80 Wide 2.6
International Game Tech IGT QQQ V.High 15.00 11.66 6.00 37.50 Wide 4.2
Dell DELL QQQQQ Med. 17.00 10.32 11.90 23.80 None
Boston Scientific BSX QQQQQ Med. 18.00 8.39 12.60 25.20 Wide

Corporate Exec Brd EXBD QQQQ High 28.00 15.10 14.00 56.00 Wide 11.7
Expedia EXPE QQQQQ High 26.00 10.26 13.00 52.00 Narrow
Interval Leisure Group IILG QQQQ High 11.00 5.81 5.50 22.00 Narrow
Ticketmaster TKTM QQQQQ V.High 12.00 4.14 4.80 30.00 Narrow
Tree.com TREE 5.27

Cash Holdings
Hare Portfolio Total 3.4
Ports_0409.qxp 4/7/09 4:27 PM Page 5

Morningstar StockInvestor April 2009 5

In a nutshell, the world has changed, and Dells model
of efficiently selling directly to consumers is being
both copied by other companies as well as diluted by
Dells expansion into areas where the company
does not have any sustainable competitive advan-
tages, such as selling to retailers, supplying storage,
and so on. That said, the company still generates
generous economic profits and free cash flow, so Dell
is far from a basket case. Either way, it appears that
Dell no longer meets the qualitative benchmarks
that I require for compaines in the Tortoise and Hare.
As such, I have the stock on a short leash and will
be looking to sell as soon as it gets near our $17 fair
value estimate.
Contact Paul Larson at paul_larson@morningstar.com
Paul Larson personally owns shares of the following Hare stocks:
ADSK, AMGN, APOL, CMP, CX, DELL, DFS, EBAY, EPE, EXBD, EXPE,
FAST, IGT, IILG, ISCA, KMX, MA, MGG, MSFT, PAYX, TKTM, TREE,
VMC, WU.
1 5 Paul has added to his position in the stock in the past month.
2 5 Paul has reduced his position in the stock in the past month.
2009 Morningstar, Inc. All rights reserved. Any opinions, recommendations,
or information contained herein: (i) is for educational purposes only; (ii) is not
guaranteed to be accurate, complete, or timely; (iii) has not been tailored to suit
any particular persons portfolio or holdings; and (iv) should not be construed
as investment advice of any kind. Neither Morningstar nor any of its agents shall
have any liability with respect to such opinions, recommendations, or information.
Morningstar has not given its consent to be deemed an expert under the
federal Securities Act of 1933. Past performance is no guarantee of future results.
Before making any investment, consult with your financial advisor. Morningstar
employees may have holdings in the stocks recommended.

Portfolio Transactions Portfolio Value Portfolio Performance Breakdown

Date of First # of Shares Cost Basis/ Total Current % Gain / % of Index This Since5
2 2
Ticker Purchase +/ Change Total Share ($) Cost ($) Value ($) Loss Portfolio Trailing Return (%) Level Month * 12 Month Inception

CMP 08-18-05 0 365 25.40 9272.35 19899.80 114.6 16.4 Hare Portfolio 15.4 -32.8 1.4
KMX 01-20-04 0 1100 14.71 16181.44 13321.00 -17.7 11.0 S&P 500 Index 842.5 18.4 -36.8 -2.8
MA 05-30-06 0 50 44.00 2199.99 8702.50 295.6 7.2 NASDAQ Composite 1621.9 19.9 -30.7 -0.5
FAST 01-29-07 0 220 38.56 8482.65 8140.00 -4.0 6.7
PAYX 06-24-02 0 250 28.55 7138.50 6835.00 -4.3 5.6 % Total Return

MGG 04-28-08 0 370 22.66 8384.20 6652.60 -20.7 5.5 pHare Portfolio p S&P 500 Index

VMC 10-03-07 0 120 87.53 10503.68 5796.00 -44.8 4.8 80

APOL 08-02-04 0 80 52.71 4216.94 5499.20 30.4 4.5

40
EPE 05-29-07 0 235 37.74 8867.87 5336.85 -39.8 4.4
0
ISCA 01-06-06 0 210 47.19 9910.09 5195.40 -47.6 4.3
2001 2002 2003 2004 2005 2006 2006 2008
WU 10-02-06 0 365 17.74 6474.63 5044.30 -22.1 4.2
EBAY 04-20-06 0 330 33.08 10917.98 4722.30 -56.8 3.9 Top Five Sectors (%) Style Breakdown (%)
ADSK 11-18-08 0 250 19.43 4857.50 4497.50 -7.4 3.7
d Ind Mtrls. 23.7 Value Blend Growth
AMGN 06-11-02 0 75 38.80 2910.25 3492.75 20.0 2.9 p50 100
o Consumer Srvcs 22.4 4 8 24 Lrg
DFS 08-08-07 0 500 21.39 10694.45 3375.00 -68.4 2.8 p25 50
p Business Srvcs 20.7 5 27 22 Med p10 25
CX 12-11-06 0 380 27.46 10434.04 2838.60 -72.8 2.3 f Energy 10.0
4 1 6 Sm
p0 10
MSFT 08-22-05 0 150 26.30 3945.63 2812.50 -28.7 2.3 a Financial Srvcs 7.0
IGT 06-27-05 0 200 28.35 5669.00 2332.00 -58.9 1.9
Morningstar ratings and fundamentals as of 4-3-09. Portfolio inception date: 6-18-01.
DELL 09-21-01 0 200 20.39 4078.00 2064.00 -49.4 1.7
1 2
Master limited partnership units have Cost basis includes commissions.
BSX 06-18-01 0 160 8.60 1376.00 1342.40 -2.4 1.1 different tax characteristics than common 3
Includes interest and dividends.
4
stocks and may not be suitable for tax- Includes capital gains.
EXBD 07-10-07 0 80 67.76 5421.14 1207.60 -77.7 1.0 5
deferred accounts such as IRAs. Please Returns since inception are annualized
EXPE 01-11-05 0 100 22.73 2273.12 1026.00 -54.9 0.8 consult your tax advisor before buying. and include dividends.
*March 4 to April 3
IILG 01-11-05 0 20 20.71 414.15 116.20 -71.9 0.1
TKTM 01-11-05 0 20 37.19 743.89 82.80 -88.9 0.1
TREE 01-11-05 0 3 11.48 34.45 15.81 -54.1 0.0

Cash Holdings 1339.98 1.1

121689.29 100.0
Focus_0409.qxp 4/7/09 5:13 PM Page 6

Lowes LOW Pauls Position

Despite strong stress-test provided by abysmal envi-
Tortoise Stock Focus | Brady Lemos ronment, Lowes remains safely profitable. Plus,
the expectations priced into the stock are very low.

Morningstars Take
Although housing market worries will pressure sales,
Rating 1-Yr High/Low Fair Value Current Price Consider Buy Consider Sell
QQQQQ $60.55/13.00 $36.00 $19.12 $25.20 $50.40 we like Lowes long-term prospects and expect
the retailer to continue to gain share in the fragmented
Size of Moat Uncertainty Market Cap Dividend Yield Revenues Stewardship
Wide Med. $28.1 bil 1.8% $48.6 bil home-improvement market. We believe Lowes
can leverage its industry-leading customer service,
% Total Return p Lowes shopper-friendly stores, and proven business
180
p S&P 500 Index
model to profitably expand domestically and abroad.
140

100
For Lowes to succeed, it must offer consumers a
compelling reason to shop its stores rather than
60
Home Depots HD (the primary competitor in virtually
20 every market), and we think it does. Given that the
-20 two firms pricing and merchandise selection are
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 09
largely comparable, the key differentiating character-
Data through April 3, 2009.
istics become customer service and shopping conve-
nience. We believe Lowes has excelled in these
Profile Lowes is the second-largest home-improvement retailer in the areas by keeping stores well staffed and designing
world and operates approximately 1,700 warehouse-format stores intuitive store layouts, among other customer-focused
throughout the United States and Canada. The companys stores
offer products and services for home decorating, maintenance,
initiatives. Not surprisingly, Lowes routinely out-
repair, and remodeling. shines Home Depot in customer-satisfaction studies.

Management and Robert Niblock became CEO and chairman in 2005 after his prede-
Stewardship cessor retired. In 2007, Niblock was given about $6.1 million worth
of salary, stock and option awards, and other incentive compensa-
tion. Overall, we believe executive compensation is reasonable,
given the companys history of impressive operating results. While
senior managers are relatively young (no one on the executive team
is older than 60), they do average several years of experience with
the company. Executive officers and directors own less than 1% of
Lowes common stock.
Valuation Our fair value estimate is $36. We assume that Lowes, like many
retailers, will struggle in 2009 because of the weak domestic
housing market and a slowdown in consumer spending. We antici-
pate fiscal 2009 sales will decrease in the low-single-digit range
year over year, driven by a high-single-digit decline in same-store
sales partially offset by revenue from new stores. Despite negative
same-store sales, we expect that Lowes will maintain a healthy
gross margin, a testament to its sound merchandising and inventory
controls. However, because operating expenses will increase at a
faster pace than sales, 2009s operating margin will probably fall to
about 6%. For comparison, Lowes operating margin averaged 10%
during the past five years. We believe same-store sales will turn
positive in 2010 and operating margins will approach 10% by 2012.
In our opinion, increased competition from Home Depot and sales
cannibalism from its own store expansion will keep store produc-
tivity and margins from reaching historical peaks.
With less than 10% share of the U.S. home-improvement
market, Lowes still has plenty of room to expand,
particularly in the quickly growing installation services
segment. Plus, Lowes stores superior shopping expe-
rience allows them to prosper even in locations where
they overlap with other home-improvement retailers.
However, taking share from Home Depot will probably
become more difficult, now that Home Depot has sold
its HD Supply business in order to focus on improving
its retail stores. While Home Depots renewed focus
on retail should lead to increased competition, were
convinced the North American market can support this
emerging duopoly. Despite its runner-up position
to Home Depot, Lowes is the 13th-largest retailer in
the world and can capitalize on its scale advantages.
Due to substantial buying power and efficient
store operations, Lowes consistently earns returns on
invested capital well in excess of its cost of capital
(even today), and we expect that trend to continue.
Focus_0409.qxp 4/7/09 5:13 PM Page 7

Morningstar StockInvestor April 2009 7

TransCanada TRP Pauls Position

Annuitylike earnings generated primarily in Canadian
Tortoise Stock Focus | Avi Feinberg dollars. If the world loses confidence in Treasuries,
this would not be a bad place to hide.

Morningstars Take
TransCanada is traversing North America to diversify
Rating 1-Yr High/Low Fair Value Current Price Consider Buy Consider Sell
QQQQQ $40.64/20.01 $38.00 $24.60 $26.60 $53.20 its operations. While the legacy pipeline business
still accounts for the bulk of cash flows, TransCanadas
Size of Moat Uncertainty Market Cap Dividend Yield Revenues Stewardship
Narrow Med. $15.2 bil 4.4% $8.1 bil growing power generation business supplements
these cash flows and adds depth to its asset base.
% Total Return p TransCanada
350
p S&P 500 Index
Stable cash flows from TransCanadas core pipeline
280 assets have come under siege from two angles:
210
gas production in the mature Western Canadian Sedi-
mentary Basin is on the decline, and regulators
140
are allowing less-generous returns. TransCanada has
70 responded by diversifying its asset portfolio.
0 Operationally, the growing Energy segment now
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 09 comprises 11,000 megawatts from natural gas,
Data through April 3, 2009.
nuclear, coal, hydro, and wind plants plus 130 billion
cubic feet of nonregulated natural gas storage,
Profile Calgary-based TransCanada is among the largest pipeline operators which contribute more than 40% of revenues.
in North America. It owns about 36,500 miles of natural gas
pipelines, most of which transport gas from Alberta to the eastern
United States and Canada. More than half the gas produced in
As the network expands in size, scope, and geography,
western Canada is brought to market via a TransCanada pipeline. cash flows become more insulated from events
About 47% of sales come from wholesale power generation. affecting a given sector or location. We think Trans-
Canadas pipeline and power generation mix
Management and Harold Kvisle was appointed president and CEO in 2001 after
merits our narrow economic moat rating, in contrast
Stewardship joining TransCanada in 1999. Overall we think TransCanadas
compensation plan provides proper incentives for its managers. to pure-play pipeline operators that typically garner
Executives do receive options to align their interests with share- a wide moat rating.
holders in the long term. Management provides excellent disclo-
sure on a number of fronts, from compensation plans to quarterly
operational data, earning TransCanada our highest corporate-gover-
TransCanadas growth prospects look bright, thanks to
nance rating. The only mark against the company is the result of its CAD 18 billion worth of growth spending planned
poison-pill shareholder-rights plan. through 2012. Of this total, nearly CAD 11 billion will
go to Keystone, a gas pipeline originating in Alberta
Valuation Our fair value estimate is $38. In our base-case scenario, revenues
that is being converted to a 1.1 million barrel-
increase 8% per year on average over the next 10 years, while
operating income increases by 9% per year. We assume the firm per-day crude pipeline and extended to the Gulf Coast.
will realize efficiencies across its vast network as it spreads addi- Trans-Canada will spend another CAD 1.7 billion
tional volumes over the same fixed cost base. Such efficiencies reinstating two Bruce Power nuclear reactors, which
cause revenues to increase more quickly than costs, resulting in
margin expansion. We give full credit for the CAD 13.5 billion of
offer some of the most attractive returns among
growth spending planned for the next three years, but we do not power-generating assets. In the long term, the flagship
model in the Northern gas projects at this point, due to significant Canadian Mainline and Alberta systems could see
uncertainties. TransCanadas preliminary estimate for the 5 billion
new volumes from the proposed Mackenzie Delta and
cubic feet per day Alaska Pipeline is CAD 26 billion, but well look
for more concrete information after the open season scheduled to Alaska pipelines, but we consider these volumes
end in July 2010. We assume a cost of equity of 10%. We also use a bird in the bush for now, given the regulatory hurdles
an exchange rate of CAD 1.25 per U.S. dollar, and any changes in and colossal investment required.
the exchange rate will affect our fair value proportionately.
Focus_0409.qxp 4/7/09 5:13 PM Page 8

Magellan Midstream Partners MMP Pauls Position

Our shares of Magellan Midstream Holdings MGG
Hare Stock Focus | Jason Stevens will be folded into this related firm later this year. For
each share of MGG, we will be receiving 0.6325 shares
of MMP. I plan on holding through the conversion.

Morningstars Take
Rating 1-Yr High/Low Fair Value Current Price Consider Buy Consider Sell
QQQQQ $43.61/18.85 $42.00 $30.00 $33.60 $52.50 With a steadily increasing budget for incremental
expansion projects, Magellan should continue to
Size of Moat Uncertainty Market Cap Dividend Yield Revenues Stewardship
Wide Low $2.0 bil 9.2% $1.2 bil deliver strong, steady cash-flow growth for years to
come. While sluggish demand for refined products
% Total Return p Magellan Midstream Partners has an impact on pipeline throughput volume, we think
400
p S&P 500 Index
Magellans inflation-indexed tariff structure and its
320 continued investment in refined product terminals will
240
generate cash-flow growth in almost any market.

160
80
0 of the largest refined product pipeline systems in the
2001 2002 2003 2004 2005 2006 2007 2008 09
Data through April 3, 2009.
Profile Magellan Midstream Partners LP is a master limited partnership
that operates pipelines and storage terminals for refined petroleum
products and ammonia in the central United States. The partnership
was formerly known as Williams Energy Partners. Its pipeline
network runs north from the Gulf of Mexico to end markets in Illi-
nois, Minnesota, and Colorado. This firm is in the process of
purchasing Magellan Midstream Holdings LP, its general partner.
Management and Chairman and CEO Don Wellendorf provides stable and competent
Stewardship guidance for Magellan. He has been a member of the executive
team since Magellans predecessor company was spun off from
Williams WMB in 2000. Magellan scores a C in stewardship, which
is in line with other MLPs. Because of the MLP structure, common
unitholders do not have the same degree of control and voting
rights as shareholders in a standard corporation would.
Valuation Our fair value estimate for Magellan Midstream Partners is $42 per
unit. While we continue to think that Magellans contract structure
and terminal operations mitigate some of the negative impact of
throughput declines, we anticipate that 2009 will be a relatively
weak year for Magellan. However, looking out over the next 10
years, we think Magellan will post average annual revenue growth
of 7%, and were modeling in some operating margin expansion,
expecting operating income to grow nearly 9% a year over the
same period. We discount cash flows using an assumed 10% cost
of equity and a 9.6% discount rate. Based on the most recent quar-
terly distribution of $0.71 per unit, Magellan yields 6.8% at our fair
value. The company expects to close the deal for its general partner
MGG during the third quarter. The transaction will result in the
elimination of incentive distributions, which will have the dual
impacts of reducing MMPs cash cost of capital and increasing the
rate at which MMP can raise quarterly distributions over time.
In our view, the key to understanding Magellan is base
hits rather than home runs. Magellan operates one
nation, connecting to more than 40% of U.S. refining
capacity. With rates that increase along with inflation
and a steadily growing demand for refined products
such as gasoline and jet fuel, Magellan will see revenue
and cash flows increase incrementally without even
adding capacity.
Even in recent quarters, when refined product demand
has declined nationwide, Magellan has been able to
deliver revenue increases. And instead of trying to buy
additional growth through acquisitions, like many of
its master limited partnership peers, Magellan instead
looks for small, highly accretive internal growth
projects that enhance the value of its pipeline system
and deepen the companys already-wide moat.
It has recently completed several of these small pipe
extension and storage projects.
We expect Magellan to continue its strategy of
branching off existing assets, incrementally increasing
system throughput and storage capacity. Moreover,
we think Magellans deliberate internal growth will
continue to create value for investors. With its solid
footprint stretching from the Gulf of Mexico north
across the Great Plains, we see Magellans prospects
remaining strong for as long as the United States
remains addicted to oil. And that could be very long
indeed.
Focus_0409.qxp 4/7/09 5:13 PM Page 9

Morningstar StockInvestor April 2009 9

Stryker SYK Pauls Position

One for the radar for the Hare.
Hare Stock Focus | Julie Stralow, CFA
Morningstars Take
Stryker excels in several orthopedic and medical equip-
ment niches. We expect the firm to continue
launching innovative new products to help expand
Rating 1-Yr High/Low Fair Value Current Price Consider Buy Consider Sell
QQQQQ $69.00/30.82 $72.00 $33.29 $57.60 $90.00 these niches and its own profitability even further
in the long run.
Size of Moat Uncertainty Market Cap Dividend Yield Revenues Stewardship
Wide Low $13.2 bil 1.2% $6.7 bil
We especially like Strykers top-tier position in the
% Total Return p Stryker highly profitable orthopedic implant market, which
400
p S&P 500 Index
possesses high barriers to entry and sticky surgeon
320 relationships. This segment accounts for about
240
60% of Strykers total sales and boasts a broad range
of products, including knee, hip, trauma, and spine
160
implants. Trauma and spine remain a feather in Strykers
80 cap, however, and going forward, were especially
0 excited by Strykers spine prospects. While numerous
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 09
small development projects continue to fill up the
Data through April 3, 2009.
bag of its dedicated spine salesforce, larger develop-
ment projects could also pan out in the next couple of
Profile Stryker develops, manufactures, and markets medical devices and years. For example, in early 2009, a Food and Drug
equipment for use primarily in orthopedic procedures. The firm Administration panel plans to review the safety and
generates most of its revenue from reconstructive implants, such as
knees and hips. Stryker also offers a wide range of operating room
efficacy of Strykers OP-1 product, a bone growth
equipment and tools used for orthopedic and other procedures. putty for spinal fusion, and Stryker aims to launch two
Hospital beds, stretchers, and other hospital equipment account for artificial spinal discs by 2010.
the rest of Strykers sales.

The balance of Strykers sales come from tools and

Management and We think fair stewards manage Stryker. Stephen MacMillan heads
Stewardship the executive team, while Strykers former, long-time CEO John
Brown chairs the board. Were glad the board employs a lead
director to alleviate some of the concerns associated with Strykers
most recent executive leaders retaining so much control of the
company. However, that doesnt address our overall concern about
the insulated board. Even though the majority of the board pass
U.S. independence standards, we think the average tenure on the
board, the large director compensation packages, a directors
consulting relationship with Stryker, and the founding familys
board seat and voting power override that litmus test. The boards
interests may not be naturally aligned with most shareholders
interests.
Valuation Our fair value estimate for Stryker is $72 per share. After double-
digit growth in 2008, we expect Strykers sales growth to decel-
erate to the high single digits in 2009, as both its orthopedic
implant and medical equipment businesses come under some
economic pressure. Beyond 2009, we expect sales growth to
rebound to about 12% compounded annually through 2013, or more
in line with our normalized expectations for Strykers businesses.
Our fair value estimate also depends on operating margins staying
around 23% through 2013. We discount our assumptions at 9.5%.
equipment to outfit surgical suites and regular
hospital rooms. Stryker is particularly prolific in oper-
ating room products, including cutting tools, medical
video equipment, and irrigation devices. These
tools often complement its orthopedic devices and
greatly improve the efficiency of surgical proce-
dures. Stryker is even a top provider of medical beds
and emergency equipment, such as stretchers.
Although not as fundamentally attractive as implants
and somewhat susceptible to economic cycles, these
offerings often expand at faster rates than Strykers
orthopedic implant products. In the long run, we think
that trend could continue assuming the company
expands as expected in international markets. Also,
with its cash-rich balance sheet and admirable
free cash-flow generation, Stryker remains in the
enviable position of having many avenues to return
value to shareholders.
Report_0409.qxp 4/7/09 4:48 PM Page 10

10

Spying the Money Supply supply representing the amount of a good or service
producers are willing to sell at various prices.
Economic Weather Report | Bill Bergman The stock of money outstanding at any point in time is
actually determined by demand as well as supply,
but the outstanding stocks are what people have called
the money supply.

Bill Bergman Remember the money supply? Decades ago, the weekly
Stock Analyst Federal Reserve reports on the monetary aggre-
gates were among the most watched and debated
news items in the markets. Like other valuable
economic indicators, however, their usefulness dissi-
pated once too many people started watching,
talking, and reacting to them. First fell M1, a relatively
narrow definition of money, including demand
deposits (checking account balances) and currency
circulating outside of banks. The focus shifted to
broader aggregates like M2 and M3, but over time, for
a variety of reasons, the money numbers lost their
historical relationships with economic activity and any
predictive ability they had for inflation and interest
rates. In 2000, as soon as the law stopped requiring the
Fed to report target ranges for the various measures
of the money stock, it did.
Now that people arent watching the money supply
as closely as they used to, might the money data have
grown in importance? There are remarkable things
going on out there these days amid the upheaval in
banking and financial markets.
The Money SupplyPast and Present
Economists talk about supply and demand, with
Money is a many-splendored thing. There are different
types of money, and the practice of taking different
things and lumping them in the same basket has a long
pedigree. For example, back in the early 1900s, on
the heels of the Panic of 1907, influential accounting
texts surfaced making the case that cash on hand
and cash in the bank were both cash, and should be
included in the same account on the balance sheet.
But during the Panic, people were putting very different
valuations on a dollar in a bank compared with one
in physical possession. A bird in the hand was worth
two in the bush.
Public policy responded to the Panic of 1907 with a
new Federal Reserve Act, establishing a central
bank in the United States with the mandate to furnish
an elastic currency. The new system was designed
to try to make the unequal things equal. Twenty years
later, in the early 1930s, the nation plunged into the
worst banking and currency crisis in its history. Currency
circulating outside of banks surged as people demanded
their deposits. The ratio of currency to demand deposits
spiked sharply higher. In hindsight, many people
faulted the Fed for allowing the overall money supply
to fall by not liquefying the banking system enough
to offset the decline in broader money aggregates.

With this historical parallel in mind, lets take a brief

Annualized Monthly Real M2 Growth 19602009 look at the money numbers recently. The Federal
Reserve Boards weekly H.6 statistical release reports
balances in M1 and M2. M1 includes currency
25%
circulating outside of banks, travelers checks, demand
20
deposits, and other checkable deposits. M2 adds
15
savings deposits, money market deposit accounts, time
10
deposit accounts totaling less than $100,000, and
5
retail money market mutual fund accounts. The Federal
0
Reserve Board also reports institutional balances
-5 held in money market mutual funds, but this number
-10 is not included in M2.
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Report_0409.qxp 4/7/09 4:48 PM Page 11
In recent months, M2 has been rising at historically
rapid rates. In fact, you have to look to a brief interval
in early 1983 (coincidentally, at the outset of the
recovery from the brutal early 1980s recessions) to see
faster growth in M2, at least since 1960. Adjusted for
inflation, the results are even more striking. Real M2
has been rising at its fastest rate since World War II.
Real M2 is included in the index of leading economic
indicators, and the recent surge looks pretty bullish.
The broader monetary aggregates arent the only ones
rising rapidly these days. A remarkable story lies
underneath the behavior of one of the narrowest money
supply numbers. Even after all the growth weve
had in electronic payment systems, currency circulating
outside of banksFederal Reserve Notes, physical
currencystill takes the largest share of overall M1.
Surprisingly, its been growing in the past decade
or so. From 1997 to 2006, for example, the currency
component of M1 rose at an average annual rate
of 7%, above nominal GDP growth. How could this
be? For one, there is growing international demand
for U.S. currency. As much as two thirds of the
stock of Federal Reserve notes may circulate outside
the United States, with the underground economy
playing a role in that regard.
But for now, currency growth has been interesting
lately, as growth has spiked sharply higher amid
the banking crisis. In the five months ended in February
2009, the currency component of M1 rose at a 15%
annualized rate, some of the fastest growth since what
happened leading up to the Great Depression. Again,
international demand likely plays an important role
Annualized Monthly Growth in Currency Circulating
Outside of Banks
30%
25
20
15
10
5 amount of money and credit for 300 million other
0
-5
-10
2005 2006 2007 2008 09
Morningstar StockInvestor April 2009 11
here, with stress in banking systems in countries
where the U.S. dollar circulates.
There has been a growing debate in recent months
about the meaning of cash on the sidelines for
potential stock market appreciation. Big, young, hungry
linebackers want to get into the game, the story
goes, and may yet turn the tide and win one for the
Gipper. But if the cash on the sidelines reflects
banking conditions more closely associated with soup
lines, banking stress, underground demand, or
precautionary wartime hoarding, idle money can
have darker implications.
What should we take awaythe bullish implications
of the sharp increase in real M2 in recent months,
or the fearful flight-to-quality implications from the
currency data? Well, at least we havent seen the
Great Depression repeat itself in one respect. The Fed
hasnt let the broader aggregates implode amid the
value destruction in our banking industry. Fighting last
centurys battle may leave us with the next centurys
problem, however. Namely, many observers have
grown wary of inflation prospects posed by our govern-
ments attempts to bolster financial markets, and
concern has also risen over these efforts given regula-
tory responsibility for the mess in the first place.
In turn, history teaches that solutions for problems of
the scope weve been dealing with can have unin-
tended and unforeseen consequences.
The law may not require the Fed to report money
target ranges anymore, but it still makes some
remarkable requests. The Federal Reserve Act stipu-
lates the Federal Reserve Board and the FOMC
shall maintain long-run growth of the monetary and
credit aggregates commensurate with the economys
long-run potential to increase production, so as to
promote effectively the goals of maximum employment,
stable prices, and moderate long-term interest rates.
This provision first arose in statute in the late 1970s.
For the last 30 years or so, weve decided it makes
sense to have 12 people determine the appropriate
people. A fundamental re-examination of our financial
regulatory structure is on the horizon, and it could
include reassessment of the value of this provision.
BB_0409.qxp 4/7/09 4:00 PM Page 12

12

Debating General Electric programs launched to incentivize energy-efficient

purchases. GEs smart-grid equipment and applica-
Bulls vs. Bears | Daniel Holland and Jim Sinegal tions have helped to line up a strong group of partners
to capitalize on the governments latest actions. These
among other actions will keep the backlog healthy.

As for the bank, there is probably no better time to have

Daniel Holland The Bull Position a captive finance organization than now. Customers
Stock Analyst GE rose to prominence because of its strengths as are unable to get financing from banks as banks have
a manufacturer, while its global scale and reach give shied away from all but the safest loans. With
it the ability to overpower virtually any competitor. governments across the world providing incentives for
These attributes will pull GE out of its current straits. investments in infrastructure, the important but
missing link in projects is often financing. GE has an
As GEs bank has been under a microscope, many excellent opportunity to earn decent spreads as it
have forgotten about the strength of one of Americas puts its equipment in the field.
General Electric GE
largest industrial companies. GE has the ability to
Star Rating QQQQQ
Uncertainty High
generate more than $10 billion of free cash flow even GEs assets are distributed across geographies and
Fair Value ($) 22.00 in mediocre operating environments. With this end markets, allowing the total portfolio to be less
Current Price ($) 10.94 backdrop, it is difficult to imagine a set of scenarios vulnerable to single asset classes eroding the entire
Market Cap ($bil) 115.5 where GE cant muscle its way out by simply putting portfolio. Loans that GE underwrites tend to be senior-
Dividend Yield (%) 11.3 its head down and paying its bills. secured notes within the borrowers debt structure,
Size of Moat Wide
meaning that the actual loss given default is much
Consider Buying ($) 11.00
Consider Selling ($) 44.00
As the worlds infrastructure needs have shifted, so less than the lower tranches of debt. Add to that GEs
1-Yr Hi/Low ($) 38.03/5.73 too has GEs portfolio with a heavy tilt toward knowledge of the value of the collateral (such as gas
Stewardship green energy. Using knowledge gained in the develop- turbines, medical equipment, and so on) as well as
P/E 6.2 ment of jet engines, GE has been able to success- the ability to redistribute repossessed assets, and the
fully enter the wind turbine space. With investments in actual risk is smaller than at traditional specialty
a diverse group of renewable energy companies, GE finance companies.
can quickly ramp up investments in winners and get out
of the others. The renewable energy markets are Because the banks balance sheet is reasonably
still fairly young, and seasoned competitors like GE matched by duration, the company could simply choose
should be able to earn healthy profits and outma- not to reinvest existing assets and avoid the markets
neuver government-dependent companies. Plus, the altogether. In a worst-case scenario, where the
American Recovery & Reinvestment Act has allo- capital markets are closed, the company can ride out
cated roughly $45 billion to the energy sector with an the storm by paying off debts with assets that are
additional $30$60 billion of customer spending coming due.

Paul Larson The Editors View
Equities Strategist
I have mixed feelings surrounding GE, and this is a
situation where I think both the Bull and the
Bear arguments make excellent points.
On one hand, GE has a highly enviable set of industrials
businesses. These operations have excellent posi-
tioning on balance, meaningful scale economies, and
decent growth prospects. If I could buy just one part
of GE, Id love to buy the manufacturing arm.
But whenever I look at GE, the thrust of the Bear case
is what keeps me from pulling the trigger. We all
know that loan losses will be huge over the coming
years in the wake of this recession and financial
crisis, but what the ultimate amount of loan losses will
be is an open-ended question. Buying GE today
BB_0409.qxp 4/7/09 4:00 PM Page 13
Jim Sinegal The Bear Position
Stock Analyst While GE is commonly considered a durable and well-
managed industrial conglomerate, I believe it is
actually something quite different. Nearly half of the
companys net income during the last three years
came from GE Capitala highly leveraged specialty
finance company with billions of dollars in holdings
ranging from Russian auto loans to French mortgages.
GE has long prided itself on being number 1 or 2 in
the markets it serves, but is it really the best lender in
Latvia? During the past few years, numerous compa-
nies used their superior credit ratings to gain entrance
into the financial netherworld; I believe theres a good
chance that GE was one of them.
GE Capitals $400 billion financial portfolio is enough
to strike fear into the hearts of any bank analyst.
The company doubled its commercial real estate hold-
ings between 2004 and 2007not the best time
in the world to be picking up commercial real estate
bargains. GE is also a major player in the private-
label credit card business, providing credit to customers
of stores like Lowes LOW or the Gap GPS. When
the going gets tough, consumers tend to stop paying
on store cards first, and the going for consumers is
certainly tough at the moment.
GEs asset-backed, equipment, and leveraged loans may
be well-collateralized, but they are made primarily
to middle-market customers with less-than-stellar credit
ratings. Only 7% of its leveraged loans were made
to companies with credit ratings better than BBB-, and
leverage does not often pair well with poor credit. GE
also made foreign exchange mortgages to borrowers
in Eastern Europe. These loans require borrowers
in a country like Hungary to make mortgage payments
requires a bit of a leap of faith that GE Capitals
previous lending decisions will lead to relatively
benign losses. Its simply not something I have
adequate confidence in at the moment. Plus, from a
portfolio perspective, the Tortoise and Hare
already own a number of companies with exposure to
credit losses (Bank of America BAC, J.P. Morgan
Chase, American Express AXP, Discover DFS), and
Morningstar StockInvestor April 2009 13
in a foreign currency in exchange for a lower interest
rate. Unfortunately, these agreements also subject
borrowers to occasionally volatile fluctuations in
exchange rates. Much like adjustable-rate mortgages
in the U.S., these loans seem attractive at first,
but can cause major problems for borrowers if local
currencies depreciate. An in-depth review of GE
Capitals balance sheet turns up far too many of these
potentially troublesome assets for my comfort.
Despite the risk on its balance sheet, the company
seems to show few signs of concern. At year-end, GE
had reserved for only $5.3 billion in potential losses
in its loan portfolio. More than 20% of GEs mortgages
in the United Kingdomoften categorized as
subprimewere delinquent in 2008, yet the company
took losses of less than 1% on the book. Addition-
ally, management seems to assume that one third of
mortgages more than 90 days delinquent will even-
tually resume payments. Barring a sudden recovery of
the global economy, I think these figures are unlikely,
and the companys predictions of limited losses
abroad are reminiscent of similar assertions made by
the CEOs of now-defunct U.S. mortgage lenders.
To date, financial companies run by realists like Jamie
Dimon at J.P. Morgan Chase JPM have fared far
better than those who continued to insist that all was
well while the economy crumbled around them.
In order to invest in GE, one must believe that the
lenders at GE Capital were far smarter and more
conservative than their peers during the past few
years. Unfortunately, their actions have not yet con-
vinced me that this was the case, and I worry the oppo-
site may be true. I recommend extreme caution.
ratcheting up this part of the portfolios risk exposure
even higher does not make much sense.
Im content to put GE on the too hard pile for now.
Or, to use our baseball metaphor, there are no called
strikes in investing. Though GE looks cheap, it is
not exactly a fat pitch. With so many other bargains
around today, Im willing to let this pitch go by.
WideMoat_0409.qxp 4/7/09 5:06 PM Page 14

14

All the companies on this watchlist have wide economic

Wide-Moat Watchlist moats. Go to http://msi.morningstar.com to track changes
throughout the month.

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

3M Company MMM QQQQQ Low 85.00 52.11 68.00 106.30 X 3.9 10.7 a Innovation and manufacturing skills are the basis of its
moat. Two thirds of sales outside U.S. Featured in Nov.
Abbott Laboratories ABT QQQQQ Low 68.00 44.12 54.40 85.00 C 3.3 14.6 b Diversified health-care giant. Biologic drug Humira and
Xience stent positioned and performing very well.
Adobe Systems ADBE QQQ Med. 26.00 24.16 18.20 36.40 C 0.0 15.2 d Acrobat and Photoshop are industry standards. Network
effect and switching costs create a superwide moat.
Advisory Board ABCO QQQQQ Med. 33.00 17.93 23.10 46.20 C 0.0 11.8 d Similar to Corp. Executive Board, but focused on health-
care and education sectors. Hurt by weak economy.
Aflac AFL QQQ V.High 20.00 21.05 8.00 50.00 X 4.8 8.0 d Wide-moat life insurers are very rare. Large presence in
Japan and U.S. Recent credit-rating downgrade.
Alcon ACL QQQQQ Low 128.00 90.31 102.40 160.00 C 2.8 13.6 b Ophthalmic leader. Novartis is buying big stake in firm.
Featured in February issue.
Allergan AGN QQQQ Med. 57.00 48.58 39.90 79.80 C 0.4 25.7 d Specialty pharmaceutical company that derives more
than one third of its revenue from Botox.
AllianceBernstein Hlding AB QQQQ High 33.00 16.93 16.50 66.00 V 5.3 d Top-tier asset manager. Suffering along with peers. Lower
asset values mean lower fees.
Altria MO QQQQQ Med. 27.00 16.16 18.90 37.80 C 7.7 10.9 d After spin-off of Philip Morris International, now focused
on U.S. tobacco market.
Amazon.com AMZN QQ High 52.00 ] 78.17 26.00 104.00 Z 0.0 52.4 d Head and shoulders above the competition in online
retailing. One of few wide-moat stocks above fair value.
American Beverage ABV QQQ High 43.00 52.93 21.50 86.00 3.2 20.6 b Dominates Brazil beer market; strong in other markets and
soft drinks. Brazilian real has fallen sharply in value.
American Express AXP QQQQQ V.High 54.00 15.33 21.60 135.00 X 4.7 6.2 a Large payment network combined with lending operation.
Rapidly rising credit losses are big concern today.
Amgen AMGN QQQQ Med. 65.00 46.57 45.50 91.00 V 0.0 11.9 c Top-shelf biotech. Anemia drugs regaining traction.
Positive recent developments in the firms pipeline.
Apollo Group APOL QQQQQ Med. 100.00 68.75 70.00 140.00 C 0.0 21.8 c Largest for-profit education firm with more than 300K
students. Hitting on all cylinders amid econ. downturn.
Applied Materials AMAT QQQQQ Med. 22.00 11.81 15.40 30.80 C 2.0 28.4 d Semiconductor equipment standard-bearer. Technological
lead and broad product portfolio. Featured in Feb. issue.
AstraZeneca AZN QQQQ Med. 49.00 34.94 34.30 68.60 C 5.9 8.3 d Number one in gastrointestinal (ulcer) drugs. Hefty late-
stage pipeline. Expanding biologic presence.
Autodesk ADSK QQQQQ Med. 28.00 17.99 19.60 39.20 C 0.0 22.5 c AutoCAD software has very high switching costs.
Purchased in Hare recently. Featured in Oct. issue.
Automatic Data Prcssng ADP QQQQQ Med. 58.00 36.67 40.60 81.20 X 3.4 15.6 a Client turnover very low. Lower interest rates actually
hurt earnings. Featured last issue.
Avon Products AVP QQQQQ Med. 36.00 21.24 25.20 50.40 X 3.8 10.4 d Brands and direct-sales model lead to high and consistent
returns on capital.
Bank of Montreal BMO QQQ V.High 35.00 28.45 14.00 87.50 Z 9.8 7.6 d Canadian banking market is very attractive with relatively
few competitors.
Bank of New York Mellon BK QQQ Ext. 32.00 29.00 UR UR C 3.3 23.8 d Mammoth in asset custody and management. Enjoys
benefits of large scale. Not as troubled as other banks.
Bank of Nova Scotia BNS QQQQ High 38.00 26.24 19.00 76.00 Z 7.4 8.6 d One of relatively few large Canadian banks. Twenty-five
percent of earnings from international operations.
Berkshire Hathaway BRK.A QQQQQ Med. 137000 [ 92490 95900 191800 Z 0.0 28.7 d Buffett still going strong. Market slump hurt reported
profits. Book value down 10% in 2008.
Berkshire Hathaway BRK.B QQQQQ Med. 4600.00 [ 3004.00 3220.00 6440.00 Z 0.0 28.0 a B share value is 1/30th of A share, and with less voting
power. Bought big stakes in Goldman Sachs and GE.
Biogen Idec BIIB QQQQ Med. 65.00 50.32 45.50 91.00 X 0.0 19.0 d Tysabri is back. Raised prices on MS drugs. Carl Icahn
bought big stake in 2007 but lost proxy battle.
*Fair value based on Morningstar analyst estimates. Data through April 3, 2009. UR 5 Under Review ] 5 Fair Value Increased [ 5 Fair Value Decreased
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Morningstar StockInvestor April 2009 15

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

Blackrock BLK QQQ Med. 133.00 138.00 93.10 186.20 V 2.3 23.4 d Merged with Merrill Lynchs asset-management business,
reaping benefits of acquisition.
The Blackstone Group BX QQQ V.High 8.00 8.07 3.20 20.00 V d Private-equity titan has generated fantastic returns, but
environment very tough today.
Boardwalk Pplne Prtnrs BWP QQQQ Low 27.00 23.10 21.60 33.80 C 8.2 12.8 d Natural gas pipeline company that is well-positioned for
growth. Large cost overruns disclosed last year.
Boston Scientific BSX QQQQQ Med. 18.00 8.39 12.60 25.20 C 0.0 c Still struggling in wake of the Guidant purchase and
higher competition. Working to pay down debt.
Bristol-Myers Squibb BMY QQQQ Med. 28.00 20.17 19.60 39.20 C 6.2 12.7 d Pharmaceutical firm experienced several management
miscues in recent years.
British Amer Tbco PL BTI QQQQ Med. 66.00 46.88 46.20 92.40 C 5.6 13.9 d Cash-cow firm. Successfully taking cigarettes into
emerging markets.
Brown & Brown BRO QQQQ Med. 22.00 [ 18.89 15.40 30.80 C 1.5 16.2 d Acquisition engine fueled by stock compensation broken
down in wake of credit crisis. Reduced moat rating.
Buckeye GP Holdings BGH QQQQQ Med. 28.00 16.07 19.60 39.20 C 3.8 17.1 d Owns general partner of Buckeye Partners LP. GPs returns
are leveraged. Could be target of purchase by LP.
Buckeye Partners L.P. BPL QQQQQ Low 46.00 36.08 36.80 57.50 C 7.2 11.5 d Pipeline firms tend to have moats because of their
geographic advantage. Buckeye is among our favorites.
Cadbury CBY QQQQ Med. 39.00 31.32 27.30 54.60 0.0 20.9 b Spun off beverages. Confectionary is highly attractive
category where branding is important.
Campbell Soup CPB QQQQQ Low 36.00 27.43 28.80 45.00 C 3.5 16.0 b Strong brands and market share in excess of 70%. Very
defensive business. Perfect potential Tortoise stock.
Canadian Imp Bk Of Cmrc CM QQQQ High 55.00 39.81 27.50 110.00 X 8.7 d Canadian banking has low degree of rivalry and is highly
insular. More hurt than Canadian peers by U.S. problems.
Capella Education CPLA QQQQQ Med. 77.00 52.77 53.90 107.80 X 0.0 31.7 d Recent addition to the watchlist. For-profit education is an
industry with multiple wide-moat firms.
Caterpillar CAT QQQQQ Med. 57.00 32.15 39.90 79.80 X 5.0 5.7 b Sensitive to economic cycles, so results may be bumpy.
Strong dollar hurts exports. Featured in Dec. issue.
CH Robinson Wrldwd CHRW UR Med. UR 48.32 UR UR X 1.9 23.3 d Leading truck brokerage with an interesting business
model. Benefits from scale advantages.
CME Group CME QQQ High 236.00 255.89 118.00 472.00 X 1.8 21.1 d NYMEX purchase complete. Hall of Fame member of
Hare. High degree of operating leverage.
Cintas CTAS QQQQ Med. 35.00 25.59 24.50 49.00 C 1.8 12.2 a Leading uniform service firm. Economies of scale story.
Showing some economic sensitivity today.
Cisco Systems CSCO QQQQQ Med. 31.00 18.16 21.70 43.40 X 0.0 14.5 d Still 800-pound gorilla of networking. Retaking significant
market share. May have rough sledding in near term.
Coca-Cola KO QQQQ Low 55.00 44.97 44.00 68.80 X 3.5 18.1 a Perhaps one of the longest-lived moats around because
of its brands and business model. Strong dollar hurts.
Colgate-Palmolive CL QQQQQ Low 79.00 60.44 63.20 98.80 X 2.7 16.5 b Has 44% worldwide market share in toothpaste. Large
overseas exposure. About 75% of sales outside U.S.
Comcast CMCSA QQQQQ Med. 25.00 14.50 17.50 35.00 C 1.7 16.9 d Unmatched ability to offer multiple services via
one connection. Microsoft recently sold big stake.
Compass Minerals Intl CMP QQQQQ Med. 85.00 ] 54.52 59.50 119.00 X 2.5 11.3 c Low-cost producer of salt and sulfate of potash fertilizer.
Eye-popping price hikes for both commodities in 2008.
Corporate Executive Brd EXBD QQQQ High 28.00 15.10 14.00 56.00 C 11.7 6.9 c Collects and sells best-practices intelligence. As a corpo-
rate discretionary, growth has significantly slowed.
Credit Suisse Group CS QQQ Ext. 48.00 33.75 6.7 d One of two top Swiss banks. Strong asset management
and private bank. Raised uncertainty rating to extreme.
Dassault Systemes DASTY QQQQ Med. 48.00 40.54 33.60 67.20 C 0.0 19.0 d French product-life management and 3-D design software
firm, focused on higher-end products.
Stew. Grade 5 Morningstar Stewardship Grade C 5 New Addition a 5 Tortoise Holding b 5 Potential Tortoise Holding c 5 Hare Holding d 5 Potential Hare Holding
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16

Wide-Moat Watchlist (continued)

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

DeVry DV QQQQ Med. 59.00 47.88 41.30 82.60 C 0.3 24.7 d For-profit education companies tend to have very high
returns on capital. Industry has been hot lately.
Diageo DEO QQQQQ Med. 80.00 47.24 56.00 112.00 4.8 11.4 a Largest spirits producer in the world. Exclusive distribu-
tion competitors cant match. Featured in Aug. issue.
Dun & Bradstreet DNB QQQ Med. 90.00 78.44 63.00 126.00 C 1.6 14.1 d Database model characterized by high barriers to entry
and low incremental costs.
Eaton Vance EV QQ High 16.00 25.08 8.00 32.00 C 2.4 16.0 d Money-management firm with below-average customer
turnover. Industry problems have stung less here.
eBay EBAY QQQQQ Med. 24.00 14.31 16.80 33.60 Z 0.0 10.5 c Moat from network effect. Auctions relatively weak,
but PayPal still going strong. Featured this issue.
Eli Lilly & Company LLY QQQQQ Med. 54.00 33.01 37.80 75.60 C 5.8 d Leading maker of mental-health drugs. Enjoys fast-
growing portfolio of new branded drugs.
Enterprise GP Holdings EPE QQQQQ Med. 50.00 22.71 35.00 70.00 X 7.9 17.1 c Owns general partners of several pipeline MLPs. Lever-
aged returns to subsidiaries performance.
Equifax EFX QQQQ Med. 34.00 [ 26.62 23.80 47.60 C 0.6 12.7 d Credit bureaus operate in an oligopoly. Like other data-
base firms, enjoys high entry barriers.
Exelon EXC QQQQQ Med. 76.00 48.60 53.20 106.40 X 4.2 11.8 b Large fleet of nuclear plants gives massive cost advan-
tage. Could benefit from potential carbon tax.
Expeditors Intl of WA EXPD QQQQQ Med. 44.00 30.66 30.80 61.60 Z 1.0 22.4 d Freight consolidation business model benefits from
network effect, scale.
ExxonMobil XOM QQQQQ Low 87.00 70.44 69.60 108.80 X 2.3 8.1 a Largest, most efficient oil company on the planet. Low oil
prices hurt in short term, could provide boost in long term.
Fastenal FAST QQQ Low 39.00 37.00 31.20 48.80 Z 1.7 19.7 c Distributor focused on the fastener market. Past Morn-
ingstar CEO of the Year winner at helm.
Federated Investors FII QQQQ Med. 30.00 [ 24.40 21.00 42.00 V 3.9 11.1 d Major player in the money-management industry. Holding
up relatively well against ugly industry backdrop.
Fiserv FISV QQQQQ Med. 61.00 37.01 42.70 85.40 C 0.0 17.5 d The nations largest bank processing firm. Enjoys signifi-
cant customer-switching costs. Featured in Nov. issue.
Forward Air FWRD UR Med. UR 17.78 UR UR X 1.6 12.1 d Has no rival with the same scale and service quality
because of its wide transport network.
Franklin Resources BEN QQQ High 70.00 [ 60.13 35.00 140.00 C 1.4 11.9 d Owns some of the best-established brand names in the
mutual fund industry. Weak results reported recently.
Genentech DNA QQQ Med. 95.00 ] 94.97 66.50 133.00 X 0.0 29.6 d Strong research-and-development capabilities. $95
buyout offer on table from Roche.
General Dynamics GD QQQQQ Med. 65.00 42.66 45.50 91.00 Z 3.3 6.9 a Large defense firm focused on cash generation. Allocates
capital with discipline. CEO change coming soon.
General Electric GE QQQQQ High 22.00 10.94 11.00 44.00 X 6.1 b Leader in large number of industries. Capital markets
freeze and recession hurting. Debated this issue.
Genzyme GENZ QQQQQ Med. 89.00 56.04 62.30 124.60 X 0.0 37.3 d Focus on products for rare diseases gives firm
unique positioning.
GlaxoSmithKline GSK QQQQQ Med. 49.00 31.11 34.30 68.60 X 6.5 11.9 b Strong drug portfolio despite recent negative safety
data on Avandia.
Google GOOG QQQQ High 500.00 369.78 250.00 1000.00 C 0.0 27.8 d Majority share of Internet search market, expanding into
several other areas. Advertising slowdown will hurt.
Graco GGG QQQQQ Med. 33.00 19.50 23.10 46.20 X 3.8 9.8 d Standout among industrial firms, dominant in several
niche markets.
Grand Canyon Education LOPE QQQ Med. 17.00 16.38 11.90 23.80 X 0.0 96.2 d Recent addition to the watchlist. 2008 IPO. Relatively
young for-profit education company.
Grupo Aero del Norte OMAB QQQ High 11.00 [ 8.40 5.50 22.00 V 7.8 51.0 d Wide-moat firm with airport monopoly in central and
northern Mexico. Featured in June issue.
*Fair value based on Morningstar analyst estimates. Data through April 3, 2009. UR 5 Under Review ] 5 Fair Value Increased [ 5 Fair Value Decreased
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Morningstar StockInvestor April 2009 17

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

Grupo Aero Pacifico PAC QQQ High 23.00 [ 19.51 11.50 46.00 C 9.5 9.7 d Airport monopoly in west-central Mexico, including
Guadalajara. Declining peso reduces value in dollars.

Grupo Aero Sureste ASR QQQQ High 43.00 [ 32.08 21.50 86.00 V 6.0 21.1 d Third major owner of Mexican airport concessions.
Completed third terminal at Cancun airport.

H & R Block HRB QQQQ Med. 22.00 [ 17.80 15.40 30.80 C 3.3 11.9 d OptionOne mortgage in process of being divested. Core
tax business still going strong.

Harley-Davidson HOG QQQQ High 28.00 16.56 14.00 56.00 X 6.6 5.9 d Among the strongest and most profitable brands. Liquidity
problems at finance arm. Featured last issue.

Hershey Company HSY QQQ Med. 37.00 36.14 25.90 51.80 V 3.3 26.6 b Largest candymaker in the U.S., with a 30% share. Wide
portfolio of consumer brands. Recent execution problems.

Home Depot HD QQQQ Med. 35.00 25.00 24.50 49.00 C 3.6 14.1 a One of only a handful of wide-moat retailers. Same-store
sales currently negative, but maintaining profitability.

HSBC HBC QQQQ V.High 55.00 32.61 22.00 137.50 13.9 d Well-positioned to take advantage of Chinese trade. Hurt
by subprime mortgage lending.

IBM IBM QQQQ Low 113.00 102.22 90.40 141.30 Z 2.0 11.4 d Bread and butter is servicing rats nest of IT infrastruc-
ture at core of most firms.

Imperial Tbco Grp PL ITY QQQ High 60.00 45.85 30.00 120.00 X 4.7 30.8 d Completed purchase of Spanish-French cigarette firm
Altadis. Cash cow. Nearly 50% share in U.K. market.

IMS Health RX QQQQQ Med. 26.00 13.10 18.20 36.40 C 0.9 7.7 d Moat comes from hard-to-replicate database of global
pharmaceutical sales. Featured in July issue.

Intel INTC QQQQQ Med. 23.00 15.95 16.10 32.20 X 3.5 17.3 d Semiconductor behemoth. Scale advantages. Antitrust
issues have resurfaced overseas.

IntercontinentalExchange ICE QQQ High 81.00 85.27 40.50 162.00 X 0.0 20.4 d Electronic exchange focused on energy futures. Benefits
from network effect. DOJ looking into regulation changes.

International Game Tech IGT QQQ V.High 15.00 11.66 6.00 37.50 X 4.2 12.0 c Slot machine manufacturer with majority share. Recent
results very weak. Debated in Aug. issue.

International Speedway ISCA QQQQQ Med. 51.00 [ 24.74 35.70 71.40 C 0.5 9.1 c Strong relationship with NASCAR sanctioning body.
2009 to be tough. Casino license in Kansas back in the air.

Intuit INTU UR Med. UR 27.73 UR UR X 0.0 22.1 d Dominates small-business accounting, tax-prep, and
personal finance software. Large switching costs.

Iron Mountain IRM QQ Low 22.00 24.95 17.60 27.50 Z 0.0 62.5 d Document storage provides high switching costs and
recurring revenue stream.

Jack Henry & Associates JKHY QQQQ Med. 24.00 17.69 16.80 33.60 X 1.8 15.0 d Bank processing firm focused on smaller banks. Enjoys
high customer-switching costs.

John Wiley & Sons JW.A QQQQ Low 40.00 32.87 32.00 50.00 X 1.6 14.1 d Publisher enjoys high returns on capital. Science and
technical franchises especially lucrative.

Johnson & Johnson JNJ QQQQQ Low 80.00 52.15 64.00 100.00 C 3.5 11.4 a Diversified health-care giant. Completed purchase of
Pfizers consumer business. On acquisition binge.

Kinder Morgan Enrgy Ptnr KMP QQQQQ Low 70.00 47.74 56.00 87.50 X 8.4 24.6 b Largest master limited partnership focused on energy
transport and storage. Pipelines tend to have moats.

Kinder Morgan Mgmt KMR QQQQQ Low 70.00 41.43 56.00 87.50 X 8.7 9.9 a Different share class of KMP without MLP tax complexity.
Pays in shares instead of cash. Spotlighted in July issue.

KLA-Tencor KLAC QQQQQ Med. 45.00 23.10 31.50 63.00 C 2.6 d Stock option backdating issue in the rear view. Still
dominates certain niches of semiconductor industry.

Landstar System LSTR UR Med. UR 36.08 UR UR Z 0.4 17.2 d Very similar to C.H. Robinson, benefiting from
network effect.

Legg Mason LM QQQQ High 35.00 17.44 17.50 70.00 C 5.5 d Now among the largest asset managers on the planet.
Large problems with performance at flagship funds.

Linear Technology LLTC QQQQQ Med. 38.00 23.14 26.60 53.20 X 3.7 12.8 d Among semiconductor companies, lower-risk. Has a
concentrated amount of industrys design talent.
Stew. Grade 5 Morningstar Stewardship Grade C 5 New Addition a 5 Tortoise Holding b 5 Potential Tortoise Holding c 5 Hare Holding d 5 Potential Hare Holding
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18

Wide-Moat Watchlist (continued)

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

Lockheed Martin LMT QQQQ Med. 92.00 67.31 64.40 128.80 X 2.9 8.6 b Defense market now highly consolidated. Sole provider
of many key defense items, particularly in aerospace.

CLorillard LO QQQ V.High 85.00 ] 62.56 34.00 212.50 V 4.4 12.2 d New addition. Dominates menthol tobacco category with
Newport brand.

Lowes Companies LOW QQQQQ Med. 36.00 19.12 25.20 50.40 X 1.8 11.6 a Scale advantages. Negative same-store sales recently,
but store base still growing.

Magellan Midstrm Hldgs MGG QQQQQ Med. 26.00 17.98 18.20 36.40 C 7.6 12.8 c General partner of pipeline firm MMP. Leveraged to
success at subsidiary. Being folded into MMP.

Magellan Midstream Part MMP QQQQQ Low 42.00 30.00 33.60 52.50 C 9.2 9.2 d Long-haul refined products pipelines and energy storage
assets. Advantage period of several decades.

Marsh & McLennan Cos MMC QQQQQ Med. 38.00 20.95 26.60 53.20 X 3.8 d Regulatory woes appear to be mostly behind this firm.
Performing relatively well in tough environment.

Martin Marietta Mtrls MLM QQQ Med. 105.00 90.25 73.50 147.00 X 1.7 22.1 d High transportation costs of heavy, low-value goods gives
geographic advantage.

MasterCard MA QQQQ High 233.00 174.05 116.50 466.00 C 0.3 c One of three major global card systems. Benefits from
cash-to-plastic shift. No exposure to credit losses.

Maxim Integrated Prdcts MXIM QQQQQ Med. 22.00 13.57 15.40 30.80 X 5.8 27.9 d We are keeping wide moat rating, but unfavorable shift
in business mix makes it a borderline situation.

McCormick MKC QQQQ Low 37.00 29.28 29.60 46.30 X 3.1 15.1 b More than 2 times larger than its next competitor in
spices and seasonings. Very stable business.

McDonalds MCD QQQ Low 59.00 56.64 47.20 73.80 Z 3.1 15.1 b Brand and scale make Golden Arches unique. Same-
store sales continue to be very stout.

McGraw-Hill Companies MHP QQQQ High 37.00 24.41 18.50 74.00 C 3.6 9.7 d Publisher and parent of S&P ratings business under both
market and regulatory pressure.

Medtronic MDT QQQQQ Low 50.00 29.83 40.00 62.50 X 2.5 11.8 b Largest medical-equipment maker with wide product
portfolio and technological lead.

Merck MRK QQQQQ Med. 46.00 26.46 32.20 64.40 C 5.7 7.3 b Patents on pharmaceutical products basis for moat.
Buying Schering-Plough in bid to gain scale, diversity.

Microsoft MSFT QQQQQ Low 35.00 18.75 28.00 43.80 Z 2.6 10.1 c Gates stepped down from day-to-day role to run charity.
Large share buyback announced. Featured in Sept. issue.

Monsanto Company MON QQQQQ Med. 145.00 81.26 101.50 203.00 X 1.2 19.7 d Large technological lead in seeds, robust current
demand. Spotlighted May 2008.

Moodys MCO QQQQ High 33.00 23.54 16.50 66.00 C 1.7 12.6 a Pressured by mortgage and structured-finance mess.
Credit markets contracting, regulatory heat rising.

Nike NKE QQQQ Med. 72.00 51.87 50.40 100.80 X 1.9 13.9 d Strong brands and global scale translate to high returns
on capital.

Northern Trust NTRS QQQ Med. 64.00 61.38 44.80 89.60 X 1.8 17.7 b Relatively conservative company. Focused on large
institutions and the wealthy.

Novartis NVS QQQQQ Low 73.00 37.51 58.40 91.30 X 4.6 10.5 a Unique in that patented pharmaceutical business married
to large generics business. Buying big Alcon stake.

Novo Nordisk NVO UR Med. UR 44.19 UR UR X 1.7 15.8 d Leader in diabetes treatments. Rivals also attracted to
growing diabetes market.

ONEOK Partners OKS QQQQ Med. 50.00 41.49 35.00 70.00 C 10.3 6.9 d Like most pipeline firms, very long advantage duration,
and relatively low risk.

Oracle ORCL QQQ Med. 21.00 [ 19.29 14.70 29.40 X 0.0 17.4 b Although wide moat is being tested, maintains enviable
position in the database market.

Paychex PAYX QQQQQ Med. 51.00 27.34 35.70 71.40 Z 4.5 17.8 c Payroll processor focused on small businesses. High
switching costs. Spotlighted in July and Aug. issues.

PepsiCo PEP QQQQQ Low 71.00 52.69 56.80 88.80 X 3.2 16.4 a Dominant salty-snacks company. Boasts 16 brands with
more than $1 billion in sales. Featured in Sept. issue.
*Fair value based on Morningstar analyst estimates. Data through April 3, 2009. UR 5 Under Review ] 5 Fair Value Increased [ 5 Fair Value Decreased
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Morningstar StockInvestor April 2009 19

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

Pfizer PFE QQQQQ Med. 26.00 [ 13.55 18.20 36.40 C 11.4 a Buying Wyeth in bid to dilute loss of Lipitor patent. Deal
looks roughly value-neutral to us at this point.

Philip Morris Intl PM QQQQQ Med. 55.00 36.20 38.50 77.00 C 5.8 10.9 d Spin-off from Altria completed in March. Strong global
tobacco brands. Featured April 2008.

Potash Corp of Sasktchw POT QQQQ High 133.00 85.71 66.50 266.00 Z 0.2 7.8 d By far the largest fertilizer producer in world. Potash
market controlled by cartels. Spotlighted April 2008.

Procter & Gamble PG QQQQQ Low 77.00 49.63 61.60 96.30 X 3.2 13.3 b Has 24 brands that generate more than $1 billion in
sales annually. Gillette integration progressing well.

Progressive PGR QQQQ High 20.00 13.73 10.00 40.00 Z 1.1 d Can apply greater underwriting insight more finely and
much faster than competitors.

Qualcomm QCOM QQQ High 48.00 41.19 24.00 96.00 Z 1.6 25.0 d Intellectual property powerhouse in wireless industry.
Patents provide very high-margin revenue stream.

RenaissanceRe Holdings RNR QQQQ High 77.00 48.99 38.50 154.00 X 1.9 d Highly technical underwriting skills. Despite 2008
hurricanes, 4Q results decent.

Ritchie Bros. Auctioneers RBA QQQ Med. 20.00 20.48 14.00 28.00 X 1.7 23.5 d Industrial equipment auctioneer benefits from
network effect.

Royal Bank of Canada RY QQQ High 37.00 [ 31.35 18.50 74.00 Z 6.4 11.9 b Largest bank in Canada by assets. Canadian market has
relatively few competitors. Holding up relatively well.

Sanofi-Aventis SNY QQQQQ Med. 46.00 27.83 32.20 64.40 C 5.4 14.1 b Plavix patent upheld. Pipeline is very full of promising
compounds in late-stage testing. Featured in July issue.

Schering-Plough SGP QQQQQ Med. 37.00 ] 23.54 25.90 51.80 X 1.1 22.0 d Not as attractive a business as other pharmaceutical
companies but still has wide moat. Featured in Oct. issue.

SEI Investments SEIC QQQ High 16.00 13.59 8.00 32.00 C 1.2 19.2 d Strong technology platform to offer investment-
processing services to private-banking and trust clients.

Spectra Energy SE QQQQQ Med. 25.00 14.87 17.50 35.00 X 6.6 8.2 b Owns giant midstream natural gas business. Featured
in Sept. issue.

Spectra Energy Partners SEP QQ Med. 19.00 ] 22.09 13.30 26.60 V 6.3 15.8 b Majority owned by Spectra Energy. Structured as MLP.
Featured in Sept. issue.

St. Joe JOE QQQQQ High 50.00 19.36 25.00 100.00 X 0.0 d Owns huge amounts of undeveloped land in Florida.
Balance sheet allows it to ride out storm.

Starbucks SBUX QQQ High 15.00 11.69 7.50 30.00 X 0.0 50.5 b Brand creates large barrier to success for competitors.
Large weakness recently. Closing outlets.

Stericycle SRCL QQQQ Med. 60.00 51.15 42.00 84.00 X 0.0 30.5 d Medical waste is a noncyclical business, and Stericycle
has a dominant share, giving scale advantages.

Strayer Education STRA QQQQ Med. 214.00 180.00 149.80 299.60 Z 1.0 31.7 d Outstanding for-profit education company. Silberman
2007 winner of Morningstar CEO of the Year award.

Stryker SYK QQQQQ Low 72.00 33.29 57.60 90.00 C 1.2 12.0 d Orthopedic devices benefit from demographic trends.
Government crackdown on industry relatively benign.

Sysco SYY QQQQQ Med. 35.00 22.93 24.50 49.00 X 4.0 12.7 a Wide-moat distributors are rare, but this one dominates.
Volumes weak recently as restaurant traffic declines.

T Rowe Price Group TROW QQQ Med. 29.00 32.24 20.30 40.60 X 3.0 17.7 d Asset manager with excellent fund lineup and
ethical reputation.

TEPPCO Partners TPP QQQQQ Med. 42.00 23.32 29.40 58.80 X 12.3 10.7 d Pipeline company enjoys significant barriers to entry and
very stable cash flows.

Time Warner TWX UR Med. UR 22.22 UR UR C 3.4 b Wide moat could come into question if/when cable
spin-off is completed.

Time Warner Cable TWC QQQQQ Med. 69.00 ] 26.30 48.30 96.60 C 0.0 b Communications capabilities competitors cannot match.
Spin-off from Time Warner planned.

Toronto-Dominion Bank TD QQQ High 41.00 37.53 20.50 82.00 Z 6.5 10.4 d High return on equity in Canada, expanding into U.S.
Buying Commerce Bancorp.
Stew. Grade 5 Morningstar Stewardship Grade C 5 New Addition a 5 Tortoise Holding b 5 Potential Tortoise Holding c 5 Hare Holding d 5 Potential Hare Holding
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20

Wide-Moat Watchlist (continued)

Star Fair Value Fair Current Consider Consider Stew. Yield Port-
Company Name Rating Uncert. Value ($)* Price ($) Buying ($) Selling ($) Grade (%) P/E folio Comment

Total System Services TSS QQQQ High 22.00 14.58 11.00 44.00 V 1.9 11.5 d Handles applications, billing, collections, and customer
service for credit card issuers.

UBS UBS QQQ Ext. 16.00 10.71 X 0.0 d Worlds largest asset manager. Strong I-bank. Received
Swiss rescue. IRS settlement threatens client secrecy.

United Parcel Service UPS QQQQ Med. 70.00 52.75 49.00 98.00 X 3.4 18.0 b Scale and network density give strong cost advantage.
Strong balance sheet. DHL domestic retreat should help.

United Technologies UTX QQQQ Med. 59.00 [ 45.63 41.30 82.60 Z 3.1 9.3 b Diversified company operating efficiently in several
industrial markets. Service contracts quite lucrative.

US Bancorp USB QQQQ High 31.00 [ 15.97 15.50 62.00 Z 8.3 9.9 b Relatively conservative. Strong position in terms of
geography and earnings growth. Featured Aug. issue.

Visa V QQQ High 70.00 60.08 35.00 140.00 0.4 94.3 d 2008 IPO. Like MasterCard, enjoys advantages from
network effect and scale. Featured April 2008.

Vulcan Materials VMC QQQQQ Med. 75.00 [ 48.30 52.50 105.00 X 4.1 c High transportation costs of low-value goods gives
geographic advantage. Tough market conditions today.

Wal-Mart Stores WMT QQQQ Low 60.00 53.80 48.00 75.00 X 1.8 15.7 a Retailing goliath enjoys cost advantages. Faring
relatively well in recent economy. Featured in Feb. issue.

Walt Disney DIS QQQQQ Low 34.00 20.00 27.20 42.50 X 1.8 9.5 b Owns theme parks, movie studios, and television proper-
ties. Outstanding brands and extensive media library.

Waters WAT QQQQQ Med. 67.00 39.10 46.90 93.80 Z 0.0 12.2 d Large share in analytical instruments important in drug
discovery, research, and manufacturing.

Weight Watchers Intl WTW QQQQQ Med. 41.00 19.80 28.70 57.40 C 3.5 8.0 d Leader of weight-loss services, with a highly recogniz-
able and respected brand. Featured in Sept. issue.

Western Union WU QQQQQ Med. 28.00 13.82 19.60 39.20 C 0.3 11.1 c Strong brand and large network of more than 375,000
agents behind wide moat.

Wyeth WYE QQQQ Med. 59.00 ] 42.74 41.30 82.60 C 2.7 13.1 b Merger with Pfizer looks highly likely. For each share,
owners will receive $33 cash and 0.985 shares of Pfizer.

Zimmer Holdings ZMH QQQQQ Med. 78.00 36.85 54.60 109.20 Z 0.0 9.9 b Leading provider of orthopedic devices. Demographic
trends on firms side.
*Fair value based on Morningstar analyst estimates. Data through April 3, 2009. UR 5 Under Review ] 5 Fair Value Increased [ 5 Fair Value Decreased
WideMoat_0409.qxp 4/7/09
Morningstar Wide-Moat Watchlist Recommendations
Stocks to Consider Buying
3M MMM
Abbott Laboratories ABT
Advisory Board ABCO
Alcon ACL
Altria MO
American Express AXP
Apollo APOL
Applied Materials AMAT
Autodesk ADSK
Automatic Data Processing ADP
Avon AVP
Berkshire Hathaway BRK.A
Berkshire Hathaway BRK.B
Boston Scientific BSX
Buckeye GP Holdings BGH
Above are all the Wide-Moat Watchlist firms trading below their Consider Buying price as well as those trading above their Consider Selling price.
Types of Economic Moats
What separates a bad company
from a good one, in large part,
is the size of the economic moat,
or competitive barrier, a firm builds
around itself. Here are four main
types of economic moats along with
explanations of how they work:
5:06 PM Page 21
Morningstar StockInvestor April 2009 21
Buckeye Partners BPL General Dynamics GD Marsh & McLennan MMC Stryker SYK
Campbell Soup CPB General Electric GE Maxim Integrated MXIM Sysco SYY
Capella Education CPLA Genzyme GENZ Medtronic MDT TEPPCO Partners TPP
Caterpillar CAT GlaxoSmithKline GSK Merck MRK Time Warner Cable TWX
Cisco Systems CSCO Graco GGG Microsoft MSFT Vulcan Materials VMC
Colgate-Palmolive CL IMS Health RX Monsanto MON Walt Disney DIS
Comcast CMCSA Intel INTC Novartis NVS Waters WAT
Compass Minerals CMP International Speedway ISCA Paychex PAYX Weight Watchers WTW
Diageo DEO Johnson & Johnson JNJ PepsiCo PEP Western Union WU
eBay EBAY Kinder Morgan Ener Part KMP Pfizer PFE Zimmer ZMH
Eli Lilly LLY Kinder Morgan Man KMR Philip Morris Intl PM
Enterprise GP Holdings EPE KLA-Tencor KLAC Procter & Gamble PG Stocks to Consider Selling
Exelon EXC Linear Technology LLTC Sanofi-Aventis SNY None this month
Expeditors Intl of WA EXPD Lowe's LOW Schering-Plough SGP
ExxonMobil XOM Magellan Midstr Hold LP MGG Spectra Energy SE
Fiserv FISV Magellan Midstr Partners MMP St. Joe JOE
High Customer-Switching Cost Advantage: Companies that Intangible Assets: Some The Network Effect: A common
Costs: If a company sells products thrive on being the low-cost companies have an advantage over trait among companies that
that customers cant get else- provider in a commodity industry competitors because of unique exploit the network effect is
whereat least not easilyit can offer lower prices to nonphysical assets such as intel- that they are the first, or one of
has high customer-switching costs. customers and still make a profit. lectual property rights (patents, the first, to create a standard
This creates a situation in which These companies create difficulty trademarks, and copyrights), in an emerging industry. These
customers are willing to pay higher for higher-cost competitors. government approvals, brand companies can sometimes
prices for products because names, a unique company culture, create monopolies.
of convenience. or a geographic advantage.
Spotlight_0409.qxp 4/7/09 5:15 PM Page 22

22

Revisiting eBay Going forward, eBays management has made it clear

Spotlight | Paul Larson and Larry Witt
Larry Witt, CFA Our eBay analyst Larry Witt recently traveled to Cali-
Stock Analyst fornia to visit a handful of companies he covers, and
one of Larrys stops was eBays annual analyst day.
Paul Larry, set the stage, how is eBays business
comprised today? Where is it headed?
Larry EBays business mix has changed significantly
during the last 15 years. Although the company
remains synonymous with online auctions, the
company has been slowly diversifying its revenue
stream over time. In fact, auctions now only represent
about one fourth of eBays total revenue. The
remaining revenue is derived from fixed-price transac-
tions (about one fourth of revenue), PayPal (about one
third), Skype (6%7% of revenue), and the balance
from advertising and eBays classified sites.
Much of the change came via mergers. Although we
wouldnt characterize eBays acquisition strategy as
excellent, we dont think it has been terrible either.
We think the success of PayPal more than offsets the
large write-down taken for the Skype acquisition, and
the remaining acquisitions are a mixed bag of smaller
deals that dont have much impact either way. In addi-
tion, as the auction business has started to decline,
all of eBays other business lines continue to grow,
providing much-needed stability.
Ebay
2004 $3.3 Billion Sales 2008 $8.5 Billion Sales
p Ebay: Auction p Ebay: Auction
p Ebay: Fixed Price p Ebay: Fixed Price
p Paypal p Paypal
p Classifieds
p Classifieds
p Other Market p Text and
Place Graphical Ads
Adjacencies p Other Market
Place
Adjacencies
p StubHub
Source: eBay p Skype
that PayPal is the companys best opportunity for
growth, and we expect management to allocate incre-
mental resources to this business. However, eBays
core marketplace segment (auctions and fixed-price)
is still very important, as it is eBays largest business
and remains solidly profitable. The profits from this
business can be used to fund PayPals growth, and
possibly to enter new business lines, as well.
P Was there anything new and meaningful revealed
in the companys presentation?
L There were no surprise announcements, but there
were a few meaningful, qualitative takeaways. First,
we think it was symbolic that management spent
the first part of the day discussing PayPal, as the
online payment unit is the companys best opportunity
for growth and will probably surpass eBay as the
companys largest segment at some point in the
future. Although we think managements expectations
for growth during the next few years are overly opti-
mistic (double revenue by 2011), we agree that
PayPal is in a great competitive position and should
continue to grow at an impressive clip.
Second, management admitted (for the first time
publicly) that eBays auction business had grown
beyond its natural size, and it expects transactions in
this format to decline over time. Rather than holding
onto the past, management is trying to move the
company forward by becoming a format-agnostic plat-
form, focused on connecting buyers and sellers
through whichever format consumers want, including
auctions, fixed-price sales, classifieds, and adver-
tising. Specifically, this means management will
increasingly make decisions (pricing, site design, and
so on) that benefit the largest number of buyers and
sellers and will not try and hold onto the past by
catering to the needs of the auction participants. We
think this strategy makes sense, as we believe a
decline in the auction business is inevitable as some
consumers simply prefer the fixed-price format.
Third, in addition to admitting this shift in consumer
preference, eBay also admitted that the user experi-
ence on its site has fallen behind competitors
Spotlight_0409.qxp 4/7/09 5:15 PM Page 23

Morningstar StockInvestor April 2009 23

eBay EBAY because of years of underinvestment. Therefore, in Skype/Classifieds/Advertising/etc. | None

Star Rating QQQQQ addition to the changes in the search function on its We arent convinced that any of eBays other business
Uncertainty Med. Web site implemented last year, the company will lines possess sustainable competitive advantages
Fair Value ($) 24.00 continue to invest in new ways to improve the user that would warrant a narrow or wide moat rating.
Current Price ($) 14.31
experience. Last, but perhaps most importantly, eBay
Market Cap ($bil) 18.4
announced that it was focusing on the secondary When considering this qualitative assessment on a
Dividend Yield (%)
Size of Moat Wide market (namely used, vintage, liquidation, and out-of- blended average basis, it is difficult to assign a moat
Consider Buying ($) 16.80 season inventory) and would not actively seek part- rating. However, we expect the company to maintain
Consider Selling ($) 33.60 ners to list new, in-season inventory. While this is a solid profit margins and returns on capital, even as
1-Yr Hi/Low ($) 33.47/9.91 retreat from eBays strategy of being a broad-based the flagship auction business declines.
Stewardship
retail platform, it was refreshing to see management
P/E 10.5
finally concede that it simply cannot compete with P Even if eBay is not as good a business as it
retailers like Amazon.com AMZN, Target.com TGT, appeared to be a couple of years ago, its stock still
and others for new, in-season inventory. looks very cheap today. What are the base-case
Amazon.com AMZN assumptions behind the $24 fair value estimate?
Star Rating QQ
P Do you think eBay still has a wide moat?
Uncertainty High
L Our $24 fair value estimate assumes the market-
Fair Value ($) 52.00
Current Price ($) 78.17 L Thats something we are continuously debating place segment grows about 5% total (1% annually)
Market Cap ($bil) 33.5 here at Morningstar. Because the company now has over the next five years. This forecast includes the
Dividend Yield (%) several different business lines, its helpful to think auction business declining by about one third over the
Size of Moat Wide about the moat of each segment. next five years, offset by modest growth in fixed-price
Consider Buying ($) 26.00
transactions and solid growth in advertising. Although
Consider Selling ($) 104.00
Auctions | Wide we expect this segment to remain solidly profitable,
1-Yr Hi/Low ($) 91.75/34.68
Stewardship EBays auction business is a classic example of the our valuation projects the segments operating margin
P/E 52.4 network effect. Buyers go to eBay because thats (excluding corporate allocations) to fall from 44% in
where the sellers are, and sellers come because thats 2008 to 39% over our forecast period.
where the buyers are. Despite our expectations for
revenue declines here, this business will remain We also forecast solid growth at PayPal and project
solidly profitable and will continue to dominate its revenue in this segment to increase at an average
market. annual rate of 17% over the next five years. We fore-
cast PayPals segment operating margin to expand to
Fixed-Price Transactions | Narrow 24% from 21% in 2008. For the overall company, we
Although the network effect still exists to some forecast revenue growth to average 6% annually over
degree, this format results in less consumer engage- the next five years and the operating margin to
ment and site traffic, as consumers are not coming contract slightly to 23% from 24% in 2008. Our valua-
back to the site multiple times to check on their bids. tion also includes about $2 per share in net cash
currently on the balance sheet.
PayPal | Narrow/Wide
PayPal also benefits from a strong network effect. At Reverse engineering a bit, if we hold all our assump-
this point, we think it will be very difficult for a tions for the nonauction businesses steady, Id have to
competitor to match PayPals scale, as we estimate assume an 80% overall decline in the auction busi-
that it already processes approximately 20% of online ness to get my model to point to a $13 stock price.
retail transactions in the U.S. We think PayPals moat
continues to widen. However, PayPals short history P Thanks, Larry. My take is that even if growth is
and the ever-present threat from credit cards make much slower than it once was, the expectations
assigning a moat to PayPal especially challenging. priced into the stock are irrationally low. At this
moment, I plan to continue holding in the Hare.
Spotlight_0409.qxp 4/7/09 5:15 PM Page 24

24

Consumer Product Insights such as trash bags and peanuts, CPG companies do not
anticipate taking back recent price hikes because
Spotlight | Mitchell P. Corwin, CFA, CPA what they are paying for inputs will increase in 2009.
There are two primary reasons why center-store
items wont reflect drops in some visible commodities.
First, CPG companies hedge a lot of their commodity
costs. As a result, companies are paying prices for
Mitchell P. Corwin, The topic du jour at the past few Consumer Analyst inputs based on agreements forged before commodities
CFA, CPA Group of New York (CAGNY) conferences has been tanked. For example, Hershey HSY expects more than
Senior Stock Analyst the rise in commodity costs, but nothing has changed $100 million in incremental commodity costs in 2009
the priorities of every company like the mammoth primarily due to locked-in agreements for commodi-
economic downturn. The weakening consumer land- ties like cocoa. Second, some commodities, such as
scape definitely took center stage in 2009. We tin plate, proteins, and linerboard, are still rising.
had five stock analysts on-site this year to hear the
General Mills GIS presentations and talk with management teams As the global economy recovers, we expect commodi-
Star Rating QQQQQ to gain deeper insights from the 28 presenting compa- ties to begin to ascend again. While not acceler-
Uncertainty Low
nies and other conference attendees. ating at the rapid rate we saw during the bubble, we
Fair Value ($) 70.00
believe some forces that drove commodity prices
Current Price ($) 50.86
Market Cap ($bil) 16.7 When it comes to shopping for everyday staples, the higher, like the U.S. ethanol policy and growing demand
Dividend Yield (%) 3.3 global economic slowdown has significantly changed for proteins in China, will re-emerge.
Size of Moat Narrow consumer behavior. Saving money is more top-of-
Consider Buying ($) 56.00 mind than ever in recent times. Private label has gained In the near term, CPG companies believe they can hold
Consider Selling ($) 87.50
significant market share. Consumers have flocked to pricing. We dont worry about companies like
1-Yr Hi/Low ($) 72.01/46.37
supercenters in the U.S. and hard discounters in Colgate CL and Campbell Soup, but we do think that
Stewardship
P/E 14.1 Europe to save on branded products. More meals are companies that operate in more commodified
being consumed at home instead of restaurants. categories, such as milk and canned fruits, will struggle
mightily. Private-label penetration accelerated
We think H.J. Heinz HNZ said it best when it comes significantly last year. According to the Private Label
Procter & Gamble PG
to consumer staples, Its a meat and potatoes Manufacturers Association, citing data from Nielsen,
Star Rating QQQQQ
Uncertainty Low
economy. Many of the companies at CAGNY touted sales of private-label food and other consumer prod-
Fair Value ($) 77.00 value messages in their anticipated advertisements ucts jumped 10% in 2008, while sales of branded
Current Price ($) 49.63 for 2009. For example, Kraft KFT and Campbells CPB products increased less than 3%. With the economy
Market Cap ($bil) 145.5 are jointly promoting a meal like grilled cheese and worsening and unemployment rising in 2009, private-
Dividend Yield (%) 3.2 tomato soup for $1. Even though value reigns supreme label penetration is likely to continue to gain on
Size of Moat Wide
this year, it doesnt mean companies are shunning branded products, in our view.
Consider Buying ($) 61.60
Consider Selling ($) 96.30
quality. Since consumers are forgoing restaurants for
1-Yr Hi/Low ($) 73.57/43.93 cheaper meals at home, packaged foods companies Disruptions in the worldwide economy have not only
Stewardship are ready with restaurant quality meals at home that created more difficult conditions for global companies
P/E 13.3 require little preparation. catering to consumers, but also those that are sensi-
tive to currency fluctuations. Its well-known that a
With the state of the economy as it is and commodities stronger dollar is hurting global firms domiciled here,
such as oil and corn well off their highs, many but what is less obvious is how currency fluctuations
perceive that consumer-packaged-goods (CPG) compa- are harming firms that have supply-chains spanning
nies costs should be lower, and that should trans- multiple countries. In other words, its not just where
late to price reductions for consumers. While prices you sell, but also where you buy. Philip Morris Inter-
have come down recently for some perishable prod- national PM talked about this at length. It cited the
ucts like eggs and a few packaged-goods products, U.K. where it sells a lot of cigarettes, but sources the
Spotlight_0409.qxp 4/7/09 5:15 PM Page 25

Morningstar StockInvestor April 2009 25

Colgate-Palmolive CL tobacco outside the country. Since the pound has been Procter & Gamble PG
Star Rating QQQQQ decimated recently, PM is effectively buying higher P&G knows the consumer, with brands that span the
Uncertainty Low and selling lower. It expects currency fluctuations alone spectrum from value offerings to more premium
Fair Value ($) 79.00 to affect its earnings per share by $0.80 this year. (PM products. We think the firm is well positioned to hold
Current Price ($) 60.44
forecasts $2.85$3.00 for the year.) market share in its categories. The company has
Market Cap ($bil) 30.3
also learned its lessons from previous downturns when
Dividend Yield (%) 2.7
Size of Moat Wide The movement of the dollar is not the only trend to turn it wasnt as defensive on market share and dialed
Consider Buying ($) 63.20 from a tail wind to a head wind recently. Emerging back on new product innovation. We dont expect it
Consider Selling ($) 98.80 markets are also showing they arent immune to the will make the same mistakes again. Moreover,
1-Yr Hi/Low ($) 80.49/54.36 global economic tsunami. Although some (Brazil, weve believed for some time P&G has opportunities
Stewardship
China) seem to be in better shape than others (Eastern to improve productivity and reduce costs, and this
P/E 16.5
Europe, Mexico), the trend seems to be downward. message certainly came through at the conference.
That said, we didnt hear any firm indicate a plan to
slow investments in emerging markets, and all were Colgate-Palmolive CL
Coca-Cola KO bullish for the long-term prospects. In fact, Coca-Cola The company has always been efficient, but at CAGNY
Star Rating QQQQ
KO just recently revealed plans to invest $2 billion in Colgate made clear that it still has room to improve.
Uncertainty Low
China over the next three years. As an early adopter of SAP, Colgate has developed
Fair Value ($) 55.00
Current Price ($) 44.97 some sophisticated promotional tools to help it refine
Market Cap ($bil) 104.1 No doubt, CPG firms face a broad set of challenges, but its offers and better test its products and posi-
Dividend Yield (%) 3.5 we believe the strongest companies will show tioning with consumers. Even more important than
Size of Moat Wide resilience in the face of the near-term head winds and the operational improvements Colgate still has
Consider Buying ($) 44.00
currently trade at valuation levels that provide long- in store, though, its deep knowledge of the oral- care
Consider Selling ($) 68.80
term investors very attractive entry points. While 28 category across the globe. We like how efficient
1-Yr Hi/Low ($) 61.84/37.44
Stewardship companies provided updates at CAGNY, below youll Colgate is, but in times like these the strong track
P/E 18.1 see a list of some of our favorite opportunities today: record the firm has also gives us comfort.

General Mills GIS Coca-Cola KO

PMI Group PMI
General Mills has a lot of momentum right now, as it No one dominates cola like Coke, with a global distri-
Star Rating QQQ has been gaining share against its largest peers bution footprint that simply cant be replicated. The
Uncertainty Ext. in cereal, yogurt, and soup. It has limited private-label firm has recently done a good job taking market share
Fair Value ($) 6.00 penetration in its categories, and solid long-term from rival PepsiCo. While we think longer term
Current Price ($) 0.67 growth potential in emerging markets. A number of these the two cola heavyweights will continue to be
Market Cap ($bil) 0.1
competitors at CAGNY acknowledged its strong relatively neck and neck in the beverages, Coke
Dividend Yield (%) 4.5
Size of Moat None
current position. This is a firm realizing margin expan- has the upper hand today. Finally, the firm is a cash-
Consider Buying ($) 0.00 sion even in the face of elevated commodity costs. flow machine, sports an attractive dividend yield,
Consider Selling ($) 0.00 and should post sustainable growth in the midsingle
1-Yr Hi/Low ($) 6.49/0.26 Diageo DEO digits as consumption increases in emerging markets.
Stewardship Diageo is the global leader in the spirits category
P/E
with eight of the top 20 alcoholic spirits brands and Philip Morris International PMI
an entrenched distribution network in more than Smoking in emerging markets continues to gain popu-
180 categories. Roughly half of the firms sales are larity, in contrast to the decline in developed markets.
generated in developing and emerging markets PM owns the international rights to the most popular
where it often has highly profitable exclusive distribu- cigarette brand, Marlboro, and its competitive advan-
tion agreements. Diageo is clearly staying the tage with the brand is intact in most of its markets.
course as the recession plays out, focusing its adver- Currently unfavorable foreign exchange movements
tising message on its iconic brands and how well are proving to be a significant head wind, but theyre
the brands have stood the test of time. only masking some strong underlying performance.
Options_0409.qxp 4/7/09 5:09 PM Page 26
26
Medical Information Technology
HealthCare Observer | Damien Conover, CFA
Damien Conover, CFA During the last couple of decades, medical groups have
Editor, Morningstar increasingly looked to health-care information tech-
Healthcare Observer nology as a way to improve efficiency and profitability.
The growing interest in new health-care software
combined with the Obama administrations budget of
$19 billion for health-care information technology
should spark industry growth. However, the health-care
technology industry remains highly fragmented and
in a relatively early phase of its development, which
increases the challenge of investing in the favorable
secular trends.
Health-Care Information Electronic health records represent a way to digitize
Technology Stocks
the old hand-written patient medical charts. As of
Drugs Price ($) Fair Value ($) 2006, just over 10% of medical groups had installed
ECLP 9.78 15.00
electronic health record systems. The lack of
MDRX 10.53 9.50
CERN 42.92 47.00 consensus on the structure of an electronic record
ATHN 24.94 33.00 system has created a major stumbling block for
market penetration. However, in 2004, the Certification
Commission for Healthcare Information Technology
(CCHIT) was formed to resolve the uniformity problem
by setting up a minimum set of standards needed
for each system. With more than $80 billion that could
be saved annually if these systems were broadly
utilized and only minor market penetration, we expect
a strong ramp in demand for new systems during the
next decade.
Near-term challenges will likely limit the growth
potential of electronic health records through 2009.
The credit crisis has weighed on hospitals willing-
ness to spend on IT. Further, while President Obamas
stimulus package for IT will surely help in time,
during the next year, many medical groups are going
to wait and see how best to use the public funds.
How to Invest in Electronic Health Records
A diverse group of many types of companies compete
in the electronic health record industry. We believe
companies that offer a wide range of information tech-
nologies will likely become some of the dominant
players in the industry. Eclipsys ECLP has broadened
its product offerings during the last few years to
include clinical, financial, and infrastructure platforms.
Although the company reported a setback in the
fourth quarter of 2008 as hospitals began delaying
spending, the company is poised to reap the long-term
rewards of increased utilization of electronic
health records.
The high growth potential and largely fragmented
nature of the health-care IT industry suggests
many mergers and acquisitions for the group. The
2008 merger between Allscripts MDRX and
Misys has created a uniquely positioned company that
can offer technology to both hospitals and smaller
physician groups, a more differentiated offering than
many of its smaller peers. Several bigger firms,
including McKesson MCK, Siemens SI, Google
GOOG, and Oracle ORCL have stuck their toes in the
health-care waters and could make a play for a
smaller health-care-focused technology company. In
our view, Cerner CERN represents a highly likely
acquisition target as the company has a well-estab-
lished electronic record and device platform.
What about Revenue Cycle Management?
Medical groups have used revenue management
systems for several years. While almost 85% of all
health-care providers use some sort of revenue
cycle management system, many of these systems
are outdated, costing providers an estimated $20
billion in lost revenue. Many of the current systems
have not kept up with the changing reimburse-
ment landscape. Also, in early 2009, the Department
of Health and Human Services created a new rule
that requires more specific coding of procedures,
increasing the codes from 18,000 to 65,000 by 2013.
The massive amount of new coding will encourage
further upgrades to revenue-cycle management
systems. We believe Athenahealth ATHN is well
positioned to answer the needs of the health
providers. The company continuously updates its plat-
form with new payer rules and corrects denied
claims automatically, not allowing the mistake to
happen again.
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Morningstar StockInvestor April 2009 27

Options for Johnson & Johnson In option terms, upside potential on a stock is called
a call option. Call options are listed instruments just
OptionInvestor | Erik Kobayashi-Solomon like stocks. Many options are listed for each under-
lying stock, the difference between the options being
the price level at which one gets the upside and the
duration of the contract. If I look at the option pricing
page for J&J (available at Morningstar.com), I see
Erik Kobayashi- My name is Erik Kobayashi-Solomon, and I am one of a list of call options with strike prices ranging from
Solomon two coeditors of Morningstars newest newsletter, $20 to $100 in $5 increments. Strike prices are the
OptionInvestor
OptionInvestor. Paul has asked us (myself and other levels above which one owns the upside. There are
Co-Editor
coeditor Philip Guziec) to begin a recurring column several lists like this, each with different durations;
here exploring ways of using option strategies to imple- the list Im looking at is the one for option contracts
For more on Morningstars
ment investments in solid, wide-moat companies in expiring Jan. 21, 2011the furthest duration.
OptionInvestor service, please
visit the following website:
the Tortoise and Hare Portfolios.
When J&J was recently trading at around $48, we
http://option.morningstar.com
I know that many people have the idea that options recommended to subscribers of our OptionInvestor
are complex, mysterious beasts that have about an service that they consider buying the January 2011
equal chance of making one rich as they do of blowing calls at a strike price of $60 for $3.10 per share. Here
Johnson & Johnson JNJ
up (as the media likes to say). My first objective is how that investment would work. Not including
Star Rating QQQQQ
with this column is to disabuse you of this idea if you trading commissions, one would pay ones broker $310
Uncertainty Low
Fair Value ($) 80.00 too hold it. Options, like automobiles, are tools. If ($3.10 per share and 100 shares per option contract)
Current Price ($) 52.15 one is trained in the use of a tool, operates it sensibly, for one contract, and this amount is the maximum
Market Cap ($bil) 144.2 and follows a few prudent, common-sense rules, possible loss on this investment. If, at option expira-
Dividend Yield (%) 3.5 it becomes essential and helpful. If one is untrained, tion in January 2011, J&J is trading at Morningstars
Size of Moat Wide
heedless, and flouts the rules of the road, one ends fair value estimate of $80, one will have the right
Consider Buying ($) 64.00
up on a hospital stretcher. My job is to teach you the to buy 100 shares at $60, for an immediate profit of
Consider Selling ($) 100.00
1-Yr Hi/Low ($) 72.76/46.25 rules of the road when it comes to options. $20 per share ($80 minus $60) or $2,000 in all. In
Stewardship this case, ones return would be 545% ($2,000 divided
P/E 11.4 For our first installment, let us take a look at a way to by $310). If J&Js shares trade at $59.99, ones
express a bullish investment opinion in a stock you option is worth nothing, but all one has lost is the
know very wellJohnson & Johnson JNJ. As Paul initial $310 invested. Even if J&Js stock were to
quipped to me, if you like J&J, youll buy the stock drop to $20 per share, ones maximum loss would still
if you love it, youll buy the options! Lets look at how be capped at just $310the call option gives us
to use options to unlock J&Js upside potential. the right to the upside, but no exposure to the down-
side beyond the initial nominal investment. At
Morningstar, we graphically represent this profit profile
Johnson and Johnson JNJ in the way illustrated in the graphic to the left.

p Market Expectations
Probability
The curve represents the markets view of the fair value
Market Strike Price Fair Value of J&Js stock, and the probability of outcomes the
Price
Effective market theoretically perceives. We are buying the
Buy Price
upside over $60 and paying $3.10 for that right, giving
us an effective buy price of $63.10. After we pass
that point into the shaded area, all the upside poten-
tial of J&J belongs to us. Note there is no shading
on the left side of the graphthis is because we have
48.34 60 63.10 80 Price ($) no exposure to the downside at all.
StocksSell_0409.qxp 4/7/09 5:17 PM Page 28

28

Stocks to SellCMS Energy and the ride. However, with Spectras asset portfolio,
market knowledge, and industry position, being along
Spectra Energy Partners for the ride may be something to consider.

Stocks to Sell | Paul Larson

At inception, Spectra Energy Partners received from
its parent company a 100% ownership interest in the
East Tennessee Natural Gas system, a 24.5% interest
This month I highlight two ideas that are worth selling in the Gulfstream pipeline, and a 50% interest in
for different reasons. The first companySpectra Market Hub Partners, a natural gas storage company.
Energy SEPis a decent company with attractive More recently, Spectra Energy dropped down the
assets, and it is a member of the Wide-Moat Watch- Saltville storage assets and P-25 pipeline, which boost
list. However, when it comes to energy master limited East Tennessee operations. We think these are all
partnerships, there are far more attractive options high-quality assets, well-suited to the MLP structure.
Spectra Energy Prtnrs SEP
available today. East Tennessee is an interstate pipeline primarily
Star Rating QQ
Uncertainty Med.
serving Tennessee and Virginia, with a delivery capacity
Fair Value ($) 19.00 In a nutshell, it does not make much sense to buy of 1.3 billion cubic feet per day. Gulfstream serves
Current Price ($) 22.09 Spectra with a yield near 6% when one can buy Hare the booming Florida market, where demand for natural
Market Cap ($bil) 1.6 Portfolio holdings Enterprise GP Holdings EPE gas is increasing at twice the national average and
Dividend Yield (%) 6.3 and Magellan Midstream Holdings MGG with better can currently deliver 1.1 bcf/d. Market Hub Partners
Size of Moat Wide
yields (near 8%9%) and higher expected growth operates two large salt dome storage facilities
Consider Buying ($) 13.30
Consider Selling ($) 26.60
rates (roughly double that of Spectra), with very in Texas and Louisiana that interconnect to multiple
1-Yr Hi/Low ($) 30.00/12.10 similar risk profiles. I would buy Spectra at the right major interstate pipelines. For both Gulfstream
Stewardship price, but that price is much lower than where the and Market Hub, major expansion projects will boost
P/E 15.8 stock trades at this moment. capacity during the next several years.

The second ideaCMS Energy CMSis a follow-up Each of Spectra Energy Partners assets earns steady
to last months sell candidate Ford F. The lesson fee-based income, primarily from long-term capacity
Magellan Mdstrm Part MMP here is that when one industry and/or geography is agreements that do not depend on actual volume
Star Rating QQQQQ exceptionally weak, there are often secondary shipped. This removes commodity price sensitivity from
Uncertainty Low
effects that may not be obvious. This companys heavy the equation. In MLP land, this makes Spectra
Fair Value ($) 42.00
Current Price ($) 30.00 reliance on Michigan (a state I would argue is in Energy Partners one of the few pure tollbooth oper-
Market Cap ($bil) 2.0 outright depression right now with no obvious way out ators, a business model we tend to favor.
Dividend Yield (%) 9.2 of the ditch) is definitely a reason to pause with this
Size of Moat Wide particular stock. Steady, predictable cash flows build confidence that
Consider Buying ($) 33.60
Spectra Energy Partners will be able to pay its
Consider Selling ($) 52.50
Spectra Energy Partners SEP distribution consistently. Growth projects and capacity
1-Yr Hi/Low ($) 43.61/18.85
Stewardship In late 2006, when Duke Energy DUK split its natural expansions will generate additional cash flows for
P/E 9.2 gas and electricity business by spinning off Spectra future distribution increases. We were not surprised
Energy SE, we wondered whether some of Spectra to see the MLP acquire Saltville Gas Storage in
Energys assets would wind up in a master limited late 2007, and we think future asset drop-downs from
partnership (MLP). With the initial public offering of its corporate parent are likely. Regardless of whether
Spectra Energy Partners in June 2007, we got our Spectra Energy pursues a drop-down strategy,
answer. Spectra Energy offered about 17% of Spectra however, we expect future growth from new projects
Energy Partners to investors. Because Spectra Energy or acquisitions.
retains control over the 2% general partner stake Analyst: Avi Feinberg
as well as the vast majority of limited partner units,
common unitholders effectively are just along for
StocksSell_0409.qxp 4/7/09 5:17 PM Page 29
CMS Energy CMS CMS Energy CMS
Star Rating QQ CMS Energy has been pursuing a back-to-basics
Uncertainty Med. strategy in recent years, selling off its noncore
Fair Value ($) 10.00 and international assets and focusing on its regulated
Current Price ($) 12.20
utility, Consumers Energy. Although we applaud
Market Cap ($bil) 2.8
the return to the pure-play utility, we have some
Dividend Yield (%) 3.2
Size of Moat Narrow reservations about this companys ability to deliver
Consider Buying ($) 7.00 solid returns to its shareholders. Its slow-growth
Consider Selling ($) 14.00 service territory, financial troubles, and meager divi-
1-Yr Hi/Low ($) 15.89/8.33 dend should give any income investor pause.
Stewardship
P/E 9.9
CMS regulated utility operates exclusively in Michigan,
a state that has been beset by economic woes,
from declining industry to the ongoing housing crisis.
Michigan has lost 305,000 jobs since 2001, 40%
of which were in the auto industry. The auto industry
currently constitutes about 3% of Consumers gross
margin, and its outlook remains bleak. The states
unemployment rate is the highest in the nation, and
its economy has shown little sign of improvement.
This is discouraging news for CMS, as regulated utili-
ties grow either through customer additions or addi-
tions to the rate base with subsequent rate increases.
Consumers expected to lose both industrial and
residential customers in 2008.
That being said, CMS has made significant progress in
recent years, reducing its heavy debt burden and
shedding nonperforming assets. The turnaround has
been modestly successful so far. Help is coming in
the form of more efficient rate regulationlegislation
has passed in Michigan that would provide for partial
decoupling of electric rates, preapproval of power
purchase agreements and plant construction over $500
million, a renewable standard of 10% by 2015, the
equal distribution of the rate burden on all customer
classes, and a streamlining of the rate-making process.
Rate structure is vital to a utilitys performance, as
regulator-set rates determine a utilitys earnings
every year. This is essentially a trade-off for granting
a utility monopoly status in its service territory,
which effectively prohibits direct competition. This
balance leads to a narrow moat for regulated
utilities, in our opinion.
Morningstar StockInvestor April 2009 29
Consumers will likely continue to file yearly rate cases
as it seeks a more favorable rate structure and cost
recovery, and its degree of success in this pursuit will
have a significant impact on CMS performance
going forward. The company favorably settled a major
electric rate case in 2008. Its latest gas rate case,
however, was a disappointment. Still, with its riskier
assets gone, the companys cash flows should be
more reliable going forward. And with the right mix of
regulatory success and efficient management,
we see potential for modest dividend growth in the
next few years. The company has said that rate-
base investments will remain a priority over dividend
increases, however. Wed recommend a wait-and-
see approach. Even legislative tail winds will have a
tough task floating a utility in Michigan.
Regarding valuation, we are maintaining our fair
value estimate for CMS Energy at $10 per share. Any
meaningful growth for this company will require
expensive rate-base investments, and current condi-
tions in the credit markets arent conducive to raising
large sums of money. Capital expenditures will
be significantly scaled back for the near term, limiting
CMS ability to take advantage of regulatory improve-
ments. Although we are optimistic about these
improvements in the long run, the weakness in
Michigans economy and the U.S. economy as a whole
is going to remain the biggest issue for this company.
Regulated utilities are at the mercy of their regula-
tors, and ratepayers are up in arms because part of the
legislation in the reform bills calls for the deskewing
of rates. Rates had been designed to dispropor-
tionately burden industrial customers and provide relief
to residential payers. Although the company concluded
its last major rate case favorably, the combination
of political pressure, poor economic conditions in
Michigan, and CMS ugly past make consistent rate
increases unlikely.
Analyst: Mark Barnett
Cover_0409.qxp 4/7/09 3:58 PM Page 30

30 Moats: The Only Constant is Change

Continued from Front Cover

of the enterprise as a whole. Or, the world might pay attention and adjust our assumptions about the
Microsoft MSFT simply change, such as through technological or future accordingly.
Star Rating QQQQQ regulatory shifts in the landscape.
Uncertainty Low Embracing ChangeA New Rating
Fair Value ($) 35.00 One example of a company that has its moat eroding We are in the process of rolling out a new rating
Current Price ($) 18.75
from its previous strength is Microsoft MSFT, which in StockInvestor that will help signal how a companys
Market Cap ($bil) 166.7
today is dealing with the implications of software competitive advantages are changing over the
Dividend Yield (%) 2.6
Size of Moat Wide as a service and cloud computing. Also noteworthy are medium term. The new rating is called the Moat
Consider Buying ($) 28.00 pharmaceutical firms, which are all grappling with Trend. With this new rating, we will put compa-
Consider Selling ($) 43.80 pricing pressure the government will undoubtedly bring nies in three different bucketsnegative, stable, and
1-Yr Hi/Low ($) 32.10/14.87 to bear in coming years. (I'll have much more on positive. Look for the new rating on all wide-moat
Stewardship
these and other disruptive trends next issue.) These stocks to appear in the May issue.
P/E 10.1
are all still good companies, and we expect positive
economic profits to be sustained for many years, I think this new rating will improve our investment
its just that the competitive advantages are in the process and overall ratings system. For one, it
United Parcel Service UPS process of falling from what they once were. will allow us to communicate greater detail about
Star Rating QQQQ how a companys moatin my view, the most
Uncertainty Med.
Likewise, many of the companies we currently have important characteristic of a companyis changing
Fair Value ($) 70.00
Current Price ($) 52.75
rated wide moat did not even exist 20 years ago. over time. Thinking more about a companys evolution
Market Cap ($bil) 52.5 Change is not always bad as it can sometimes benefit should hopefully improve the accuracy of the
Dividend Yield (%) 3.4 companies, making them stronger. Perhaps a projections of our analysts, who are responsible for
Size of Moat Wide competitor dies or pulls back from a market, lowering projecting the cash flows that stand behind our fair
Consider Buying ($) 49.00 the degree of rivalry within an industry. (Witness value estimates. Our staff will actively avoid the
Consider Selling ($) 98.00
UPS UPS in the U.S. after DHLs recent retreat.) practice of looking at just what a firms moat is today,
1-Yr Hi/Low ($) 74.90/37.99
Stewardship
Another common example of an expanding moat may and instead consider in greater detail where a
P/E 18.0 be with companies that have economies of scale firms moat is headed tomorrow, as well as the rate
combined with opportunities to invest capital at high of change.
rates of return, increasing the scale advantages
that much further. (See Compass Minerals CMP on We still expect all of our wide-moat companies to
the next page.) Or, a technological shift could actually generate positive economic profits during the next 20
be a beneficial thing for a given company. years. But it is a fact that some companies are
losingor building upontheir competitive advan-
Either way, the message is that a companys competi- tages faster than others. This new rating will help
tive positioning is always changing, and we should us sort out those companies that are likely to be on the
Wide-Moat Watchlist for many years to come from
those more likely to see their moat rating downgraded
Company Life Cycle Example to narrow or none, such as we just experienced
with Dell DELL. Plus, it will allow us to identify up-and-
ity
p

th

ne
tu

ur
ow

cli
ar

at

coming companies that are perhaps narrow-moat

Gr
St

De

Return on Capital (%)

now, but could become wide-moat down the road.
25

20
Here are examples of the moat trend reports for three
15
companies in StockInvestor s model portfolios.
10
These firms have economic moats in different stages
0
of either eroding, not changing much, or building.
-5

-10
Amgen AMGN | Moat Trend: Negative
0 5 10 15 20 25 30
We think Amgen will face a variety of new challenges
Years p Return on Invested Capital p Cost of Capital Economic Profits
Cover_0409.qxp 4/7/09 3:58 PM Page 31

Morningstar StockInvestor April 2009 31

Amgen AMGN during the next several years that could begin to tive-net-present-value) projects. For example, the firms
Star Rating QQQQ erode its sizeable moat. Generic biologic competitors Goderich rock salt mine has a remaining life of
Uncertainty Med. for two of its products have already launched 144 years, based on current rates of production, and
Fair Value ($) 65.00 outside the U.S., and as some of the oldest marketed Compass is investing to expand annual production
Current Price ($) 46.57
biologics on the marketand most profitable from 7.25 million tons to 9.0 million tons during the next
Market Cap ($bil) 48.2
Amgens products would be among the first to see several years. This will leverage the inherent cost
Dividend Yield (%)
Size of Moat Wide generic competition in the U.S., as well. Reim- advantages endowed by Mother Nature on this unique
Consider Buying ($) 45.50 bursement for dialysis drug Epogen will be bundled asset, furthering the companys scale advantages.
Consider Selling ($) 91.00 with other dialysis products in the future, which As Compass expands its rock salt production capacity
1-Yr Hi/Low ($) 66.51/27.00 could pressure prices and margins. Arthritis and psori- at Goderich, it will likely be gaining market share.
Stewardship
asis drug Enbrel is seeing a high level of new Compass rock salt operations do have at least some
P/E 12.0
competition, and its dominant market share is starting operating leverage (the numbers point to this), so
to shrink. Finally, despite the novelty of denosumab we argue that as production from Goderich increases,
an osteoporosis drug candidateand strong record in that mines cost position could improve relative to
Diageo DEO the clinic, a high number of competitors, including mines with stagnant production.
Star Rating QQQQQ
cheap generic versions of other successful drugs, could
Uncertainty Med.
weigh on its potential, particularly given the current In addition, the firms Great Salt Lake (GSL) sulfate of
Fair Value ($) 80.00
Current Price ($) 47.24 administrations focus on taming health-care spending. potash evaporation businessoperating with
Market Cap ($bil) 33.3 Analyst: Karen Andersen another world-class assethas access to minerals
Dividend Yield (%) 4.8 that have an estimated life in excess of 100 years
Size of Moat Wide Diageo DEO | Moat Trend: Stable based on current rates of production, and Compass is
Consider Buying ($) 56.00
Diageos wide economic moat stems from its unrivaled investing to expand production by more than 20%
Consider Selling ($) 112.00
distribution scale, its strong portfolio of brands, during the next few years. The cost advantage at the
1-Yr Hi/Low ($) 86.19/40.93
Stewardship and exclusive distribution agreements in the U.S. Great Salt Lake solar evaporation facilities stems
P/E 11.4 the most profitable spirits market in the world. from lower energy costs and lower raw-material needs.
Although slower global economic growth has cooled As Compass expands the GSL facility, it increases
sales growth for Diageo recently, particularly its advantage relative to energy-intensive operations,
Compass Minerals Intl CMP
in Western Europe, Diageos market share remains and decreases its reliance on purchased raw
Star Rating QQQQQ steady, and the firm continues to generate robust materials. In this way, the cost position of GSL should
Uncertainty Med. cash flows. improve in relative terms.
Fair Value ($) 85.00 Analyst: Elizabeth Collins, CFA
Current Price ($) 54.52 Diageo is able to maintain its wide economic moat
Market Cap ($bil) 1.8
because of its entrenched relationships with retailers More New Features
Dividend Yield (%) 2.5
Size of Moat Wide
in the U.S., something no other competitor has been The Moat Trend is not the only new thing I have to
Consider Buying ($) 59.50 able to replicate. The economies of scale and brand introduce this issue. You may have noticed that
Consider Selling ($) 119.00 equity that Diageo has established in developed on Pages 2627 we have another set of new, regular
1-Yr Hi/Low ($) 87.88/36.40 markets throws off tons of cash, which the company columnsshort, insightful pieces from my fellow
Stewardship has plowed into investing in emerging markets, strategists on Morningstars specialized services,
P/E 11.3
where its scale is well ahead of its competitors. Healthcare Observer and OptionInvestor. Yet, more
Analyst: Ann Gilpin new features are coming. Meanwhile, all the content
that was formerly printed in the Roundup Journal
Compass Minerals CMP | Moat Trend: Positive is still available; please make sure to sign up for our
Compass Minerals has strong competitive advantages e-mail alerts and/or visit the StockInvestor Web
as a result of its world-class, low-cost rock salt site msi.morningstar.com to read all of the between-
and sulfate of potash specialty fertilizer resources. issue market commentary.
We believe Compass moat is widening because of its
ability to continue investing in high-return (posi-
Cover_0409.qxp 4/7/09 3:58 PM Page 32

Morningstar StockInvestor
Volume 8, Number 10
Equities Strategist and Editor
Paul Larson
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Pat Dorsey
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