Three Wide Moat, Buffet Worthy Stocks

Jeremy Glaser Morningstar April 28, 2011

It's a common refrain among stock investors that they want to be more like Warren Buffett. This shouldn't come as a huge surprise given Buffett's gleaming long-term record and folksy charm. But it is much easier said than done to follow Buffett's advice in buying companies with strong competitive advantages at a discount and holding them for extremely long periods of time. It takes strong nerves to fight the natural human urge to want to trade more frequently or buy into the latest craze.

But just copying everything Buffett buys isn't a ticket to success. Buffett himself has said many times that he expects his investment returns going forward to pale in comparison with his past success. The sheer size of his portfolio means he isn't able to take advantage of smaller opportunities and must instead focus on mega deals such as buying Burlington Northern Santa Fe or Lubrizol . Investing or buying a small company just doesn't have a major impact on Berkshire Hathaway's displayPTip('BRK.A', 'BRK.A','YTD', '', '', '', '', '', '','msg','P');displayPTip('BRK.B', 'BRK.B','YTD', '', '', '', '', '', '','msg','P'); earnings power.

In many ways, individual investors dealing with much more modest sums are at an advantage. They can buy into small firms without worrying about moving the stock price. In March 2010, we ran a screen for some companies that fit Buffett's investing style but were much too small for him to consider. Of the firms that passed, we highlighted Total System Services displayPTip('TSS', 'TSS','YTD', '', '', '', '', '', '','msg','P');, Corporate Executive Board displayPTip('EXBD', 'EXBD','YTD', '', '', '', '', '', '','msg','P');, and Landstar System displayPTip('LSTR', 'LSTR','YTD', '', '', '', '', '', '','msg','P');.

These picks have done well during the last year. The S&P 500 rose by around 19% since March 2010. Total System Services is up 31%, Executive Board gained a whopping 56%, and Landstar beat the index by 22%. Of course beating the market over a one-year period isn't a ticket to an early retirement. But investors who bought these solid firms at cheap prices are likely smiling now.

Ahead of the Berkshire Hathaway Annual Meeting this weekend, we thought we'd run the screen again using the Premium Stock Screener and see if any new names appeared. We searched for wide-moat firms that had Morningstar Ratings for stocks of 4 or 5 stars. We also required that these firms have been free-cash-flow positive for the last three years, produced returns on equity in excess of 10%, and have a market cap of less than $5 billion. Alas, the rising market has greatly reduced the number of cheap stocks, leaving only one firm, MSCI displayPTip('MSCI', 'MSCI','YTD', '', '', '', '', '', '','msg','P');, on the list.

We decided to raise the market-cap limit (to $50 billion) in an effort to uncover more values. Although firms this large are more likely to be on Buffett's radar screen, we still think they represent decent values. Click here to run the updated screen for yourself.

Below are three firms that passed the screen: MSCI displayPTip('MSCI', 'MSCI','YTD', '', '', '', '', '', '','msg','P');4 Stars | Fair Value Uncertainty: Medium | Market Cap: $4.3 BillionFrom the Premium Analyst Report:MSCI is a pioneer in the development of global equity indexes--it has been in the index business since 1969 and calculates more than 120,000 indexes daily. The company's equity indexes have become the de facto standard in international equity indexing, with a market share of about 90%. While favorable market conditions played a part, MSCI's dominant position stems from the must-have nature of its products and a network effect. As investors increasingly use indexes to track equity returns and benchmark their performance, indexes get deeply entrenched in investors' processes and become more indispensable, leading to high switching costs. The company's competitive position is very defensible because of the powerful network effects associated with the universal adoption of its indexes.

Avon Products displayPTip('AVP', 'AVP','YTD', '', '', '', '', '', '','msg','P');4 Stars | Fair Value Uncertainty: Medium | Market Cap: $11.8 BillionFrom the Premium Analyst Report:Recent missteps, particularly in faster-growing emerging markets, have hindered Avon's progress, and we don't believe these challenges will abate over the near term. In addition, the company has not been completely immune to the headwinds created by the slowdown in global economic activity. However, given Avon's long history of managing through global economic disruptions, as well as its focus on controlling costs and empowering its sales representatives around the world, we believe the firm will navigate through the current crisis and continue generating strong returns on invested capital over the longer term.

Zimmer Holdings displayPTip('ZMH', 'ZMH','YTD', '', '', '', '', '', '','msg','P');4 Stars | Fair Value Uncertainty: Medium | Market Cap: $11.8 BillionFrom the Premium Analyst Report:Zimmer shines in several orthopedic niches that typically possess high barriers to entry and sticky surgeon relationships. Although these positive attributes should help the firm generate excellent returns for the long run, economic woes and increased regulatory scrutiny have tested Zimmer shares in recent years.

Data as of April 25, 2011.

Woodstock for Capitalists

If you can't make the pilgrimage to the 2011 Berkshire Hathaway Shareholders Meeting on April 30, be sure to tune in to Morningstar.com for pre-meeting commentary and on-the-ground coverage in Omaha. We'll bring you on-the-spot article, blog, and video reports featuring commentary from equities strategist and StockInvestor editor Paul Larson, Morningstar Berkshire analysts Greggory Warren and Drew Woodbury, and conference attendees. Click to see more.

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