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Stock Strategist

We Expect Big Returns for This 5-Star Stock

We think this gambling stock will rise more than 20%.

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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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MGM Mirage, Inc.
Moat: Narrow | Risk: Avg | Price/Fair Value Ratio*: 0.70 | Three-Year Expected Annual Return*: 24.2%

What It Does: MGM Mirage (MGM) owns and operates casinos in Nevada, Mississippi, and Michigan. MGM acquired Mandalay Resort Group in 2005, adding casinos such as Mandalay Bay, Luxor, and Excalibur to its portfolio, which already included the likes of the Bellagio, MGM Grand, New York-New York, Mirage, and Treasure Island. The firm also owns a 50% interest in the Borgata in Atlantic City and a joint venture in Macau. MGM is also constructing the $7 billion Project City Center on the Strip.

What Gives It an Edge: Morningstar analyst Sumit Desai credits MGM Mirage with a narrow economic moat. The firm controls almost 50% of the hotel rooms, 39% of all slots, and 38% of the table games on the Las Vegas Strip. The company also owns almost 250 acres of underutilized or undeveloped land on the Strip. Desai believes MGM's leading market share of hotels and gaming positions on the Strip gives the firm pricing power and helps maintain disciplined growth among competitors. In addition, the company is expanding aggressively into other markets, namely Macau and Atlantic City. Desai thinks MGM's strong portfolio of brand names, such as Bellagio and Mandalay Bay, carry a strong cachet even in nongaming regions, giving the company an opportunity to enter into the resort business as well.

What the Risks Are: MGM Mirage's revenue is highly dependent on the Las Vegas market. Disruptions in air travel could send shock waves through the local economy. The company's high leverage makes it even more vulnerable to any downturn. Finally, an upcoming surge in gaming capacity on the Las Vegas Strip could lower the returns on MGM's Project City Center.

What the Market Is Missing: Desai believes the market is overly concerned with the impact a consumer-spending slowdown would have on MGM and other casino operators in general. MGM earns about 75% of its profit from Strip properties, all of which are heavily dependent on travel trends, which could slow during a recession. However, Desai considers the gaming industry to be relatively economically resilient. Although incremental gamblers may choose to postpone their trips to Vegas during the short term, a healthy convention business should help offset any leisure visitors. Also, Desai's valuation for the firm is more dependent on MGM's ability to grow via new developments, like CityCenter on the Strip and MGM Macau, and less on short-term fluctuations in revenue and profits. Desai assumes only modest growth for the company's existing properties, with strong growth coming from the company's new-property pipeline.

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