These Stocks Could Provide Some Stability in an Unsettled Market

Stock (Photo credit: rubyblossom.)

New York, Jan.14, stock advice .- With the S&P 500 hitting a five-year high amid heightened levels of policy and economic uncertainty, investors could be well-served by keeping firms with predictable cash flows on their radars.
The S&P 500 hit a five-year high this week after posting an impressive run of 16% in 2012 and then tacking on another 3.3% so far in 2013. Although there has been plenty of volatility, stocks have mostly shrugged off U.S. fiscal concerns, the eurozone crisis, and the emerging-markets slowdown. It isn't that investors have been ignoring these issues; it's that corporate fundamentals have looked fairly solid during the last few years. But now stock prices seem to have fully caught up with fundamentals. The median price/fair value of all stocks rated by Morningstar's equity research team now stands at 1.00. That is to say, the median company is now trading at exactly what our analysts estimate the firm's intrinsic value is. One year ago that ratio stood at 0.90. A fully valued market, combined with today's heightened levels of policy and economic uncertainty, creates an unsettling environment for stock investors. Morningstar head of global equity and credit research Heather Brilliant stated recently that "market volatility will be a way of life in 2013" and that long-term investors will once again have to focus on security selection in order to outperform. 

Investors looking to have a somewhat smoother ride through 2013 might want to take a close look at Morningstar's fair value uncertainty ratings for individual stocks. Analysts not only peg what they think a company is worth, they also put a rating on how wide the potential range of outcomes is for that firm. Companies with low uncertainty ratings are ones that the analyst feels confident about the future path of the business, that generally have solid financial strength, and that are likely to stay the course regardless of macroeconomic concerns. These firms still will likely see a fair deal of volatility, but we'd expect it to be less extreme than that of the broader market.

  

We used the  Premium stock screener to find firms that look undervalued (ones that have Morningstar Ratings for stocks of 4 or 5 stars) and that have low uncertainty ratings. Here are three names that passed the screen for your radar. You can run the screen for yourself by  clicking here. 

 American Electric Power (AEP)  
| Economic Moat: Narrow  
From the  Premium Analyst Report:
American Electric Power, long the stalwart regulated utility providing consistent earnings growth and dividend payments, faces a business transformation that could change its earnings and dividend growth profile. AEP generates 95% of its earnings from its regulated operations now. However, as Ohio transitions toward deregulation, the company will reposition assets, and could reduce generation to just 65% of its 2012 level. We forecast approximately 20% of revenue will come from competitive operations in 2016, exposing AEP to volatile power, coal, and natural gas commodity markets. 

 Costco Wholesale (COST)  
| Economic Moat: Narrow  
From the  Premium Analyst Report: 
Costco offers investors the highest near-term cash flow visibility in our defensive coverage sector. The company books nearly all its profits 12 months in advance. Membership revenue, although deferred over the life of the annual membership, is paid at the beginning and accounts for nearly all of Costco's operating profits. Furthermore, even after fee increases and in recessions, member renewal rates have remained steady around the 86% level. Costco cardholders renewed their memberships at an 86% rate during and after the Great Recession. Therefore, we have a very high level of certainty in our near-term financial forecast. Moreover, cash, a debit card, or an  American Express (AXP) charge card are the only forms of payment accepted at Costco. In our view, this indicates a high credit quality customer base, which we believe can better withstand economic downturns. For these reasons, as well as being free cash-flow positive and in a net cash position, Costco trades at premium valuation to nearly all of the other companies in our defensive space. 

 Novartis (NVS)  
| Economic Moat: Wide  
From the  Premium Analyst Report: 


In an industry plagued by stagnant growth, Novartis is well-positioned with diversified operating platforms and an industry-leading number of new potential blockbuster drugs. Strong intellectual property supporting multi-billion-dollar products, combined with an abundance of late pipeline products, creates a wide economic moat. While the 2012 patent loss on Diovan and manufacturing problems in the consumer division will weigh on near-term growth, the company's strong strategic position should lead to steady long-term growth. ... Continue to read. 

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