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| Posted: Tue Feb 27, 2007 4:00 pm Post subject: Our Newest 5-Star Stocks |
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Following is a sampling of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.
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Group 1 Automotive
--Business Risk: Average
--Economic Moat: Narrow
--Price/Fair Value Ratio*: 0.72
--Consider Buying: $52.40
--Consider Selling: $85.20
Unlike most auto manufacturers, which battle high fixed costs that keep them from earning their cost of capital, auto retailers have proved that they can be good businesses. Franchise laws help to keep powerful manufacturers and would-be competitors at bay. Dealers also enjoy considerable support from manufacturers through so-called "floor-plan" financing, a form of low-cost secured borrowing, and other subsidies that reduce working capital needs and marketing costs. Finally, though new car sales account for over 60% of dealership revenues, they make up less than 30% of operating profits. The bulk of operating profits come from higher-margin sales of used cars, parts, and services, helping stabilize dealer finances despite the cyclical nature of new car sales. For these reasons, among others, Morningstar analyst John Novak thinks Group 1 Automotive (NYSE:GPI - News) enjoys a narrow economic moat. And while Group 1's profitability and same-store growth has lagged peers', Novak believes that the company's new CEO will improve its execution.
Motorola
--Business Risk: Average
--Economic Moat: Narrow
--Price/Fair Value Ratio*: 0.77
--Consider Buying: $19.30
--Consider Selling: $31.30
After years of struggles, once-stodgy Motorola (NYSE:MOT - News) has refocused on its complementary handset and telecom infrastructure businesses while shedding its slower-growing, more capital-intensive businesses like its automotive division and semiconductor unit Freescale (NYSE:FSL - News). These moves have resulted not only in an impressive transformation of the company's culture and morale, but also a financial turnaround that Morningstar analyst John Slack believes is sustainable. With nearly 1 billion wireless handsets expected to ship worldwide in 2006, supply-chain management, procurement, and distribution are imperative for success, and Slack believes scale creates sustainable advantages and competitive barriers to entry. Motorola and industry leader Nokia (NYSE:NOK - News) have it, and no one else comes close. Scale allows Motorola to extract the best terms from suppliers and ensures that its orders are filled ahead of rivals', which is important when components are in tight supply. Distribution is arguably even more important, particularly from an emerging-markets perspective. This is best illustrated by Nokia, which hasn't really had a solid handset lineup in three years but is still able to gain share by the brute force of its distribution system in India and China. Motorola has smartly used its newfound scale and profitability over the past two years to invest heavily in distribution in developing markets.
NovaStar Financial
--Business Risk: Speculative
--Economic Moat: None
--Price/Fair Value Ratio*: 0.47
--Consider Buying: $9.40
--Consider Selling: $22.10
Morningstar analyst Ryan Lentell believes mortgage originator NovaStar (NYSE:NFI - News) has value but cannot understate the risk associated with its shares, explaining his "speculative" risk rating. Lentell also does not think NovaStar is suitable for income-seeking investors and foresees a dividend cut in 2007. But grim as the short-term picture might look amid a sharp increase in loan delinquencies, Lentell also points out that there's a real business here. In fact, NovaStar generally sells the loans it originates into off-balance-sheet asset-backed securities. Investors buy these securities, while NovaStar retains a residual interest and earns interest from the mortgages in excess of that owed to the security. The company also retains servicing rights in the mortgages it sells and earns fees for servicing the mortgages. This structure is extremely beneficial in good times as it allows NovaStar to use a high amount of leverage on its portfolio of loans, which magnifies its profits. Yet, as the stock's recent swoon well attests, it also increases the firm's risk and can cause pain as the market cools. Nevertheless, if NovaStar is able to avoid financing problems and steer through the storm in the subprime world, it should benefit from the upheaval in the long run, as many competitors will be forced out of the market. This should lead to increased credit spreads and higher profits for the survivors.
To get a complete tally of stocks that have recently jumped to 5 stars--as well as our full list of 5-star stocks including our consider buying and selling prices, risk ratings, and moat ratings--simply take Morningstar Premium Membership for a test spin. Click here to sign up for a free trial.
https://members.morningstar.com/memberstpages/pm_stocks.html?referid=ONEWSTOANA
* Price/fair value ratios calculated using fair value estimates and closing prices as of Friday, Feb. 23, 2007. |
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