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Stock Strategist

Two New 5-Star Stocks on the Radar

Plus, we're holding steady on two homebuilders.

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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.

To get 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.

New 5-Star Stocks

  • Administaff (ASF)
  • MGIC Investment (MTG)
  • (For a complete listing of our 5-star stocks, click  here.)

    Administaff

    • Economic Moat: Narrow
    • Business Risk: Average
    • Price/Fair Value Ratio*: 0.75
    • Consider Buying: $35.50 or Below
    • Consider Selling: $57.60 or Above

    Administaff (ASF) is the dominant player among professional employer organizations (PEO) that focus on human resource outsourcing for small businesses. A PEO handles common human resource functions such as employee benefits, payroll, and workers' compensation. Although HR outsourcing is nothing new, PEOs are unique in that client employees are simultaneously employed by the client as well as the PEO. Under this co-employment structure, Administaff aggregates workforces of multiple clients into a single bargaining entity, which keeps benefit and insurance costs below what individual clients could obtain on their own. In addition to controlling costs, this integrated relationship leads to high customer retention rates for Administaff. Administaff's desired client profile--high average employee salary, low workers' compensation exposure, and stable business profile--also confers benefits, as it typically leads the firm to companies that are outsourcing their HR functions for the first time. This lack of head-to-head competition for new business is a primary reason that returns on investment have been so favorable. Further increasing Administaff's pricing ability and revenue growth is its method of billing clients as a percentage of employee wages instead of a fixed fee. As payrolls increase, which they tend to do annually, Administaff benefits. In Morningstar analyst Joel Bloomer's opinion, these factors taken together earn Administaff a narrow moat.
     Full Analyst Report: Administaff 

    MGIC Investment

    • Economic Moat: Narrow
    • Business Risk: Average
    • Price/Fair Value Ratio*: 0.76
    • Consider Buying: $58.60 or Below
    • Consider Selling: $95.20 or Above

    MGIC's (MTG) clients--the rapidly consolidating mortgage originators--have flexed their muscles and breached the firm's moat by establishing captives--private insurers--to reinsure MGIC's portfolio. Thus, to win mortgage insurance business from these lenders, MGIC must cede as much as 40% of its traditional flow channel insurance premium to the captive in return for protection against large losses. Because lenders established a loss rate well above historical levels, the net effect is a reinsurance policy that pays MGIC only in dire times of mortgage defaults. Morningstar analyst Jim Ryan suspects that while some of the costs of captive reinsurance cut into MGIC's margins, the better part of it is passed on to the mortgage borrower. After all, it's the borrower who pays, not the lender. While Ryan expects pressure from piggyback mortgages--a mortgage financing arrangement that circumvents the need for mortgage insurance--to ease in the future, MGIC still must play catch-up in the foreign arena, as the company has yet to make significant inroads abroad. Challenges notwithstanding, the shares look like a bargain at recent levels, even after allowing for a commensurate margin of safety.
     Full Analyst Report: MGIC Investment

    * Price/fair value ratios calculated using fair value estimates and closing prices as of Thursday, April 5, 2007.

    Recent Updates on 5-Star Stocks

    • Our Thesis for Hovnanian Enterprises Remains Intact (Maintaining)
    • Lennar Posts First-Quarter Results (Maintaining)

    Our Thesis for Hovnanian Enterprises Remains Intact (Maintaining)
    Recent news for homebuilders and mortgage companies has been bad and getting worse. Over the past month, the market has continually lowered its expectations for sectors tied to real estate, and stock prices have taken some hits. These headlines support our previous projections of an atrocious 2007 for Hovnanian Enterprises (HOV), with a bleak operating environment continuing for some time. We are maintaining our fair value estimate. As the housing bubble continues to deflate, we will be paying close attention to Hovnanian's liquidity and cash flows. So long as management is able to continue to pay its bills and conduct limited operations, it should not be forced to dispose of its current land holdings at a loss.
    Parrish Glover

    Lennar Posts First-Quarter Results (Maintaining)
    Lennar's (LEN) first-quarter results indicate the company may be nearing the end of a period of using significant discounts to move through expensive inventory. Consequently, this year will probably see revenue declines more in line with industry peers, but with slightly better profitability. We're maintaining our fair value estimate, as we've modeled a significant revenue slowdown over the next two years and still believe strongly that Lennar is one of the best-positioned builders to benefit from what's likely to be a lengthy slump.
    Eric Landry

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