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5 Undervalued Innovative Stocks

These names from the Morningstar Exponential Technologies Index are trading at 4- and 5-star levels.

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Disruptors like Apple (AAPL) and Amazon.com (AMZN) helped catapult the technology-heavy Nasdaq to a near-44% gain last year. Perhaps such innovators that are developing and adeptly harnessing new technologies should be booming--after all, these companies are transforming the way we live.

Nevertheless, we at Morningstar aren’t willing to overpay for a stock, no matter how transformative a company may be. So today, we’re hunting for inexpensive innovators in the Morningstar Exponential Technologies Index.

As background, the Morningstar Exponential Technologies Index is designed to identify companies across sectors in the early stages of developing or using transformative technologies. It features 200 companies identified by Morningstar's equity research team as being positioned to experience meaningful economic benefits as a user or producer of promising technologies.

Morningstar has identified nine technology themes:

Big Data and Analytics: Capabilities with data sets too large and complex to manipulate or interrogate with standard methods or tools. Related subthemes include the Internet of Things, machine learning, and artificial intelligence.

Networks and Computer Systems: Technology leaps ranging from hyperconnectivity and integrated systems, to service continuity and new software-defined architectures, will have a massive impact on the way people think of connecting applications and software with hardware.

Nanotechnology: The branch of technology that deals with dimensions and tolerances of less than 100 nanometers, especially the manipulation of individual atoms and molecules. We see a range of potential applications spanning medicine, computing, manufacturing, and travel.

Medicine and Neuroscience: Sciences, such as neurochemistry and experimental psychology, that deal with the nervous system and brain. Key advancements in unlocking the human genome have created an infrastructure of biomarkers, while paradigm shifts in biotechnology that can alter the immune system are radically changing the way we treat diseases.

Energy and Environmental Systems: This involves the exploration of renewable energy sources--including solar, wind, water, and batteries. As organizations set processes to help reduce environmental impacts and increase operating efficiency, new avenues for technological advancement across sectors will open up.

Robotics: The branch of technology that deals with the design, construction, operation, and application of robots. Advances in robotics, specifically when combined with other exponential technologies, have seemingly infinite potential applications, spanning technology, industrial, medical, and consumer-facing channels.

3D Printing: A process for making a physical object from a three-dimensional digital model. The emerging trend is ready for mainstream consumption and has ample potential to disrupt several industries, from industrial manufacturing and medicine to consumer products and retail.

Bioinformatics: The science of collecting and analyzing complex biological data. The "quantified sell" trend of acquiring data to quantify aspects of an individual's daily life has exponential potential to positively affect both the duration and quality of life.

Financial-Services Innovation: The search for and acknowledgement of emerging funding sources, platforms, currencies, and stored and transferred value. We not only think about opportunities to efficiently expand production but also the underlying currencies used (including cryptocurrencies), as well as structural shifts in technology and payment delivery methods.

Analysts score companies within those themes on a scale of 0 (no or little exposure to the theme) to 2 (significant exposure), relying on models to project growth over five, 10, and 20 years. We've isolated the five highest-scoring companies from the index that our analysts cover and that are undervalued by our metrics today. We present our analysts’ business outlooks for each of those companies, as well as what themes each has exposure to.

Roche Holding AG ADR (RHHBY)
Morningstar Rating (as of Jan. 29, 2021): 5-stars
Theme Exposure: Big Data and Analytics, Nanotechnology, Medicine and Neuroscience, Bioinformatics

“We think Roche's drug portfolio and industry-leading diagnostics conspire to create sustainable competitive advantages. As the market leader in both biotech and diagnostics, this Swiss healthcare giant is in a unique position to guide global health care into a safer, more personalized, and more cost-effective endeavor. Strong information sharing continues between Genentech and Roche researchers, boosting research and development productivity and personalized medicine offerings that take advantage of Roche's diagnostic arm.

"Roche's biologics focus and innovative pipeline are key to the firm's ability to maintain its wide moat and continue to achieve growth as current blockbusters face competition. Blockbuster cancer biologics Avastin, Rituxan, and Herceptin accounted for 32% of Roche's revenue in 2019, and all three are seeing strong headwinds from biosimilars. However, Roche's biologics focus (more than 80% of pharmaceutical sales) provides some buffer against the traditional intense declines from small-molecule generic competition. In addition, with the launch of Perjeta in 2012 and Kadcyla in 2013, Roche has expanded its breast cancer franchise, and Phesgo, a subcutaneous coformulation of Herceptin and Perjeta, is launching in the United States. Gazyva, now approved in CLL and NHL and in testing in lupus, will also extend the longevity of the Rituxan franchise. Avastin's lung cancer sales are vulnerable to biosimilars and competition from new therapies Opdivo and Keytruda, but Roche's own immuno-oncology drug Tecentriq launched in 2016, and we see peak sales potential above $10 billion. Roche is also expanding outside of oncology with MS drug Ocrevus ($9 billion peak sales) and hemophilia drug Hemlibra ($6 billion peak sales).

"Roche's diagnostics business is also strong. With a 20% share of the global in vitro diagnostics market, Roche holds the number-one rank in this industry over competitors Siemens, Abbott, and Ortho. Pricing pressure has been intense in the diabetes-care market, but new instruments and immunoassays have buoyed the core professional diagnostics segment.”

Karen Andersen, strategist

Microsoft (MSFT)
Morningstar Rating (as of Jan. 29, 2021): 4-stars
Theme Exposure: Big Data and Analytics, Networks and Computer Systems, Robotics, Bioinformatics, Financial Services Innovation

“Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader. In our view, Microsoft has become one of two public cloud providers that can deliver a wide variety of PaaS/IaaS solutions at scale. Additionally, Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model. The company has also embraced the open-source movement. Finally, Microsoft exited the low-growth, low-margin mobile handset business and is driving gaming to be more cloud-based. These factors have combined to drive a more focused company that offers impressive revenue growth with high and expanding margins.

"We believe that Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $20 billion business, it grew at a staggering 56% rate in fiscal 2019. Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud. Since existing customers remain in the same Microsoft environment, applications and data are easily moved from on-premises to the cloud. Microsoft can also leverage its massive installed base of all Microsoft solutions as a touch point for an Azure move. Azure also is an excellent launching point for secular trends in AI, business intelligence, and Internet of Things, as it continues to launch new services centered around these broad themes.

"Microsoft is also shifting its traditional on-premises products to become cloud-based SaaS solutions. Critical applications include LinkedIn, Office 365, and Dynamics 365. Like any transition, the initial move is painful, as both revenue and margins drop. However, Microsoft is now on the back end of that, where revenue have accelerated and are more predictable, and margins are increasing. Office 365 retains its virtual monopoly in office productivity software, which we do not expect to change in the foreseeable future. We believe that customers will continue to drive the transition from on-premises to cloud solutions, and revenue growth will remain robust with margins continuing to improve for the next several years.”

Dan Romanoff, analyst

     Dig deeper: Gaming and Azure Drive Microsoft Strong Results

Merck (MRK)
Morningstar Rating (as of Jan. 29, 2021): 4-stars
Theme Exposure: Big Data and Analytics, Nanotechnology, Medicine and Neuroscience, Bioinformatics

“Merck's combination of a wide lineup of high-margin drugs and a pipeline of new drugs should ensure strong returns on invested capital over the long term. Further, Merck is through the worst of its patent cliff, which should remove the heightened generic competition the company has experienced over the past years. And after several years of only moderate research and development productivity, Merck's drug development strategy is yielding important new drugs.

"Merck's new products have mitigated the generic competition, offsetting the recent major patent losses. In particular, Keytruda for cancer represents a key blockbuster with multi-billion-dollar potential: It holds a first-mover advantage in one of the largest cancer indications of non-small cell lung cancer. Also, we expect new cancer drug combinations will further propel Merck's overall drug sales. However, we expect intense competition in the cancer market with several competitive drugs likely to report important clinical data between 2020 and 2021 in earlier stage cancer settings. Other headwinds include generic competition, notably to diabetes drug Januvia, likely to start as early as 2022.

"After several years of mixed results, Merck's R&D productivity is improving as the company shifts more toward areas of unmet medical need. Owing to side effects or lack of compelling efficacy, Merck experienced major setbacks with cardiovascular disease drugs anacetrapib, Tredaptive, Rolofylline, and TRA along with Telcagepant for migraines. Safety questions ended the development of osteoporosis drug odanacatib. Despite these setbacks, Merck has some solid successes, including a successful launch for its PD-1 drug Keytruda in oncology. Following on this success, Merck is shifting its focus toward areas of unmet medical need in specialty-care areas, and Keytruda is leading this new direction. We expect Keytruda's leadership in non-small cell lung cancer will be a key driver of growth for the company over the next several years.”

Damien Conover, director

Facebook (FB)
Morningstar Rating (as of Jan. 29, 2021): 4-stars
Theme Exposure: Big Data and Analytics, Networks and Computer Systems

“Facebook is the largest social network in the world, with 2.5 billion monthly active users. The growth in users and user engagement, along with the valuable data that they generate, makes Facebook attractive to advertisers in the short and long term. The combination of these valuable assets and expected continuing growth in online advertising bodes well for Facebook, as the firm generates strong top-line growth and remains cash flow positive and profitable. Facebook has increased users and user engagement by providing additional features and apps to keep them engaged within the Facebook ecosystem. With more Facebook user interaction among friends and family members, sharing of videos and pictures, and the continuing expansion of the social graph, we believe the firm compiles more data, which Facebook and its advertising clients then use to launch online advertising campaigns targeting specific users. While utilization of the data is under scrutiny in different markets, we think Facebook’s large audience size will still attract the ad dollars. Growth in Facebook’s average ad revenue per user indicates advertisers' willingness to pay more for Facebook-placed ads, as they expect high return on investment from the targeted ads.

"We believe Facebook will continue to benefit from an increased allocation of marketing and advertising dollars toward online advertising, more specifically social network and video ads, where Facebook is especially well-positioned. The firm’s Facebook app, along with Instagram, Messenger, and WhatsApp, is among the world’s most widely used apps on both Android and iPhone smartphones. Facebook is taking steps to further monetize its various apps, such as providing interactive video ads. It is also applying artificial intelligence and virtual and augmented reality technologies to various products, which may increase Facebook user engagement even further, helping to further generate attractive revenue growth from advertisers in the future.”

Ali Mogharabi, senior analyst

     Dig deeper: Facebook Reports Impressive Q4; Raising FVE to $335

Biomarin Pharmaceutical (BMRN)
Morningstar Rating (as of Jan. 29, 2021): 4-stars
Theme Exposure: Big Data and Analytics, Nanotechnology, Medicine and Neuroscience, Bioinformatics

“BioMarin is amassing a portfolio of genetic-disease therapeutics, making historical comparisons with Genzyme difficult to avoid. Commercialization and research and development expenses have kept BioMarin in the red, but we're confident in the profit-generating power of its rare-disease treatments, and BioMarin's turn to non-GAAP profitability in 2017 looks sustainable. With a deep in-house pipeline and the ability to supplement growth with strategic acquisitions, BioMarin is in a strong position.

"BioMarin's life-saving therapies may serve only a few thousand patients globally, but with six-figure price tags on most products and high barriers to entry, we see this as a very attractive marketplace. Genzyme (now Sanofi) and BioMarin formed a 50/50 joint venture to market BioMarin's first drug, Aldurazyme, for the treatment of mucopolysaccharidosis I, or MPS I. BioMarin's MPS VI drug, Naglazyme, is maturing, but still seeing solid growth due to use in emerging markets like Brazil and higher (more expensive) dosing as young patients mature; we think peak sales will surpass $400 million. BioMarin is also well-positioned to treat the entire spectrum of patients with phenylketonuria, or PKU, one of the world's most common metabolic disorders. While generic versions of Kuvan (approved to treat mild to moderate PKU) will launch in the U.S. in 2020, more potent drug Palynziq launched in 2018 in the U.S. to serve adult patients with PKU, including patients with more severe forms of the disease, and BioMarin is pushing a gene therapy for PKU into early clinical trials. PKU is well-diagnosed thanks to state-mandated newborn screening programs, and no alternative drug therapies exist. Vimizim in Morquio A syndrome and the launch of Brineura in 2017 to treat CLN2 disease should also drive growth.

"In the pipeline, vosoritide has shown the ability to restore normal growth rates in young patients with the most common form of dwarfism (launch likely in 2021), and hemophilia A gene therapy valoctocogene roxaparvovec, or Roctavian, should launch in mid-2022 (after a complete response letter in August 2020). We think each could generate peak sales near $1 billion.”

Karen Andersen, strategist

     Watch: Healthcare Outlook: Coronavirus at Center Stage 

 

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Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.