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Market Update

Stocks Our Favorite Large-Cap Managers Have Been Buying

Morningstar medalist managers picked up these names during the fourth quarter of 2016.

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U.S. stocks posted strong gains in the last quarter of 2016: The S&P 500 rose about 4% while the blue-chip-dominated Dow Jones Industrial Average gained 8.7% for the quarter. 

The biggest market mover during the period was Donald Trump's surprising presidential election win. That unexpected victory triggered shifts in performance across markets as investors rewarded companies that seemed poised to benefit from deregulation and infrastructure spending.

Those shifts allowed smart stock-pickers to snap up companies at decent prices. Here are some of the stocks that a few of our favorite medalist managers running large-cap funds bought during the quarter.

Burns McKinney, who comanages the Silver-rated  AllianzGI NFJ Dividend Value (PNEAX), added Apache (APA) to the portfolio during the fourth quarter. The selling point was the energy company's 1.76% dividend yield, compared to an average yield of about 0.5% by its peers, he said, adding that Apache's natural gas play in the Permian Basin should provide the firm with long-term growth. Value-focused McKinney notes that Apache "is spread out a little bit too thin" by being in Egypt, the U.K., and Canada, but he likes that the company has been selling a large part of its Egypt stake and reinvesting in North America.

Morningstar strategist Mark Hanson says the $11 billion in divestitures Apache has executed over the past few years should allow the company to "emerge leaner and meaner and with more capital to chase onshore opportunities." Apache earns a 2-star rating from Morningstar as of this writing, suggesting that its shares are overvalued today.

John DeGulis, who takes a value approach to investing, bought Walgreens Boots Alliance (WBA) for the Silver-rated Sound Shore (SSHFX), which he comanages. DeGulis wasencouraged by the new management team and their strong relationships with pharmacy benefit managers. PBMs are third party administrators of prescription drug programs for corporations.

"With Stefano Pessina's leadership they made some agreements with UnitedHealth Group (UNH) and  Express Scripts (ESRX) and won a bunch of new business," DeGulis said. The possible RiteAid Corp (RAD) purchase by Walgreens could add to the strength of the stock, he added.

"We believe there is a strong likelihood of Walgreens driving sales volume and scale through becoming a preferred PBM pharmacy and enhancing its presence in many underpenetrated regions through the acquisition of Rite Aid," says Vishnu Lekraj, senior equity analyst for Morningstar. "If Walgreens can capture the synergies of these two tactics, it could offset secular industry headwinds."

The stock carries a 2-star rating as of this writing, suggesting that shares are overpriced relative to their fair value.

Large-growth focused  Touchstone Sands Capital Institutional Growth (CISGX), which earns a Bronze rating from Morningstar, added  Netflix (NFLX) stock to its portfolio.

"On-demand video streaming services will reach 90% penetration of broadband homes worldwide over the next five to 10 years, providing a powerful secular tailwind," noted comanager Frank Sands in his latest letter to shareholders. "While we expect Netflix to substantially increase its U.S. subscriber base, we believe its international expansion will be the primary driver of long-term growth."

Sands expects the number of international subscribers will more than triple as Netflix goes global.

"Netflix is the premier subscription video on demand provider, and we expect it will use its Big Data to remain so," notes Morningstar's equity analyst Neil Macker.

Despite the growth opportunity here, Morningstar thinks the stock is overvalued relative to its estimate of its fair value; the stock earns just 1 star today.

Bradley Hinton, comanager of Bronze-rated  Weitz Partners Value (WPVLX), acquired  Visa (V) during the fourth quarter. He said global purchase volume growth should continue in the double digits for the next five to 10 years, so it's a "toll booth" on global economic activity.

"Card penetration still has room to grow, still cash and checks account for a large portion of transactions around the globe," especially in emerging economies as consumers in those markets move up the income and wealth curves, Hinton said.

"Visa is winning the payment wars," says Morningstar senior equity analyst Jim Sinegal.

The company, which earns a wide moat rating from Morningstar and is currently undervalued, trading in 4-star range as of this writing, has built formidable barriers to entry. As a result, its competitive set is limited.  

"As consumer spending around the world grows and digital methods continue to take share from cash, this wide-moat company should continue to flourish for years to come as an effective toll booth on global spending," says Sinegal.

Thomas Huber, portfolio manager of Silver-rated T. Rowe Price Dividend Growth  (PRDGX) picked up  Johnson Controls (JCI).

"The newly combined company with Tyco International should give it room for slow and steady margin expansion driven by deal-based synergies," Huber said. "Strong momentum in power solutions and a solid order book in building efficiency allow a good setup for 2017," he added.

Morningstar equity analyst Brian Bernard says after narrow-moat Johnson Controls merged with Tyco in September and completed the spin-off of Adient, its automotive seating business in October, the company is a "true multi-industrial player."

"The Adient spin-off and Tyco merger result in a more profitable and less cyclical business, one with much less exposure to the volatility of the automotive original equipment manufacturer market, and more exposure to higher-margin, recurring service revenue," says Bernard. "Tyco's suite of security and fire-protection products and services complements Johnson Controls' building efficiency business, and the combination should drive synergies and enhanced market penetration."

According to Morningstar, the stock is currently undervalued, trading in 4-star range.

Gold-rated  FMI Large Cap (FMIHX), managed by Pat English, bought  Cerner (CERN) and  Oracle (ORCL) last quarter.

Cerner, a supplier of healthcare information technology, is a "terrific, 'lock-box' franchise with high levels of recurring revenue, high switching costs, a dominant market position, high returns on capital, and a pristine balance sheet," English said in a recent shareholder letter.

Oracle is the world's largest database provider and second largest applications provider.

"Oracle's transition to a cloud-based business model has been bumpy, with the shift from licenses to subscriptions pressuring profitability," which has given the fund an opportunity to buy the stock "at a relatively attractive price," English said.

As of this writing, Cerner is trading in 4-star rating, suggesting that it's underpriced relative to Morningstar's fair value estimate. Lekraj assigns the stock a wide moat, meaning that the company possesses significant competitive advantages.

"The integrated and essential nature of the firm's offerings makes it a key player within the healthcare IT market and will allow it to produce economic profits over a significant period," he notes.

Morningstar equity analyst Rodney Nelson said of Oracle: "The rise of cloud computing and open-source software over the past two decades has caught the software giant somewhat flat-footed. While many of its products are under siege, we think the firm can maintain its status near the top of the software food chain."

Like Cerner, Oracle earns a wide moat rating; its shares are fairly valued, trading in 3-star range as of this writing.

Lastly, Bill Nygren, who manages the Gold-rated  Oakmark Select (OAKLX), bought Ally Financial (ALLY) during the quarter. Ally Financial provides financial products and services to auto dealers and their customers.

"U.S. auto sales are near record levels, and credit losses are below long-term averages," Nygren said in his latest letter to shareholders. "Cyclical pressures will be more than offset by continued internal improvements, such as funding cost reductions and improving the capital structure," he added.

Morningstar analysts don't formally cover Ally, but according to the firm's quantitative models, the company's shares are fairly valued today

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Manuela Badawy is a freelance columnist for Morningstar.com. The views expressed in this article do not necessarily reflect the views of Morningstar.com.

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