There's still a way to find quality growth stocks at good bargains, and to prove it, below are three perfect examples says Paul Larson of Morningstar StockInvestor.
The Wide Moat Focus Index and its track record continue to generate a great deal of interest. As a reminder, the index is composed of the 20 US-based wide-moat companies with the lowest price/fair value ratios.
In mid-June, we rebalanced and reconstituted the index as we do every quarter. We replaced six of the 20 companies in the index, and the vast majority of the changes were driven by simple valuation concerns—meaning, all six of the companies that were dropped still have wide moat ratings, and just two of the six additions had recent upgrades to their moat ratings.
Here is a summary of three companies that were added to the index:
National Oilwell Varco (NOV)
This company has been in the Hare portfolio since last October. Nicknamed “No Other Vendor,” NOV is the dominant supplier of oil-drilling equipment. It benefits from efficient scale given the niche markets it serves, its significant intellectual property, and switching costs as drillers standardize on NOV’s equipment.
I suspect the stock has gotten cheap because oil prices have swooned in recent weeks, but the secular trend of drilling for oil in areas of increasing difficulty is alive and well. The stock does not exactly have heroic expectations priced in, trading at just six times our 2012 EBITDA projection and less than ten times forward consensus earnings estimates.
Micros Systems (MCRS)
We initiated coverage of this firm in April and rated it with a wide moat. The company is the largest supplier of the software and hardware that run point-of-sale systems used in the restaurant and hotel industries.
Given the integral nature of these systems to customers’ operations, there are very significant switching costs. This explains the renewal rate of approximately 95% and returns on invested capital near 40%.
We expect the company will continue to post steady revenue growth rates in the low teens while enjoying positive operating leverage for several years. The stock is not exactly dirt cheap at 21 times forward consensus estimates, but this is a very high-quality company that fits the mold of “growth at a reasonable price.”
United Technologies (UTX)
This is the lone firm added to the index that fits the mold of the Tortoise instead of the Hare. What this industrial firm lacks in flashy growth, it more than makes up with good management and a high degree of consistency.
Charting the company’s free cash flow, dividends paid, and shares repurchased over the years, the figures have reliably been up and to the right. The company’s Otis elevator division arguably has some of the ultimate switching costs, and maintenance revenue here carries high margins.
The company’s shares may be cheap because of federal budget concerns, but the Department of Defense is responsible for only about 20% of revenue. The stock trades at just over ten times forward consensus estimates, and with an indicated yield of 2.9%.
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