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Market Update

3 Recent Buys From Top Large-Cap Managers

Medalist managers picked up Cognizant, Johnson & Johnson, and Antero Resources during the first quarter of 2017.

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This year started with a bang. Markets posted strong gains on optimism the new U.S. president would make good on his campaign promises. The S&P 500 Index gained 6%, the Dow Jones Industrial Average rose 5%, and the Nasdaq Composite jumped 10% during the first three months of the year.

Despite rising valuations in the equity market during the quarter, some managers were able to find opportunity. Here are a few pickups that Medalist managers running large-cap stock funds made during the quarter.

Cognizant Technology Solutions (CTSH) was added to both Bronze-rated  Artisan Value (ARTLX) and Glenmede Large Cap Growth (GTLLX) during the first quarter. This IT services vendor provides technology consulting, application outsourcing, and cloud services.

Artisan's comanagers took the opportunity of pressured shares due to a slowdown in earnings and fears surrounding U.S. immigration reform to establish a position in what they call an "above-average business at a slightly below-average price."

"It's a quality company with a solid management team and long track record of success," Artisan comanager George Sertl said in the fund's latest report.

"We like that it has recently renewed its focus on fundamental improvements and more efficient capital allocation, and we believe the business is well-positioned for evolution in the industry. Further, its balance sheet is strong with a large amount of net cash, and it generates ample free cash flow," he added.

Cognizant earns a 3-star rating from Morningstar as of this writing, which suggests shares are fairly valued today.

"With revenue at a compound annual growth rate of approximately 17% over the past five years, Cognizant has become a notable competitor to industry incumbents," writes Morningstar equity analyst Andrew Lange in his latest report. "While we do not forecast such a high revenue growth rate over the next five years, we think the firm can significantly outperform the overall global IT services industry, for which Gartner projects a 4.6% CAGR."

Morningstar assigns Cognizant a narrow economic moat rating rooted in customer switching costs.

"The firm's commitment to client satisfaction (through its two-in-a-box operating model) has led to the formation of critical long-term relationships and an intimate knowledge of customer business processes; we estimate the company's strategic client retention ratio to be in the mid- to high-90s," he says.

Bronze-rated T. Rowe Price Value (TRVLX) added Johnson & Johnson (JNJ) during the first quarter.

"Johnson & Johnson is one of the largest and most diverse healthcare companies in the world. Shares traded down in recent months as investors favored more cyclical or economically sensitive names," T. Rowe Price Value portfolio manager Mark Finn said in the fund's quarterly report.

Johnson & Johnson reported earnings and revenue forecasts that missed analysts' expectations, with the company anticipating slowing growth in its pharmaceuticals business.

"We initiated a position as shares reached attractive valuations," Finn said. "Despite the near-term challenges, we like that the company offers substantial predictable cash flow, a solid balance sheet, room for margin expansion, and an attractive dividend."

Johnson & Johnson is currently trading in 2-star range, suggesting its shares are overvalued relative to Morningstar's fair value estimate. But the stock is one to consider on weakness.

"We believe Johnson & Johnson carries one of the widest moats in the healthcare sector, supported by intellectual property in the drug group, switching costs in the device segment, and strong brand power from the consumer group," says Morningstar healthcare sector director Damien Conover. He expects annual earnings per share growth of 4% over the next three years, with growth in new drugs offsetting some patent losses.

"We expect flat operating margins in the near term as a result of waning cost-remediation efforts in the consumer group and increasing cost-containment efforts throughout the firm offsetting margin pressure due to the loss of patent protection on several high-margin drugs, including immunology drug Remicade," he says.

During the first quarter, Silver-rated Sound Shore (SSHFX) added Antero Resources (AR), a natural gas explorer and producer in the United States and Canada.

There are several reasons to like Antero, according to comanager John DeGulis.

"Although it's a reasonably young company, the management team has decades of experience. They have a very good acreage position in the Marcellus where they are the largest producer," DeGulis said.

In addition, he said, "natural gas prices and stocks are down, expectations are low, and you have a company that has very low cost reserves and production, that we think it endures even in a $3 gas environment, and it has been growing its units by 20% a year."

Further, DeGulis notes that the stock is relatively inexpensive, trading around 6 times 2018 cash flow while its peers trade at 8 times. And the company hedges more aggressively than its peers: DeGulis says that the company has hedged most of their production through 2020.

"The combination of hedging at good prices, having very low cost reserves, and using some leverage, they are able to get better returns on equity through the cycle than your average E&P company," DeGulis added.

Antero is among Morningstar's favorite ideas, too. It earns a 4-star rating as of this writing, suggesting its shares are undervalued.

"Antero Resources is the most active driller in the Appalachia region. We believe it is also one of the most attractively priced," Morningstar analysts noted in a recent white paper.

They note that although natural gas still makes up around 75% of the firm's production, a good portion of its acreage is in areas with a fairly high liquids content--which differentiates the company from its peers.

"Drilling and completion costs have declined steadily over the past two years in the Marcellus and Utica plays, and there is scope for further efficiency gains that could lower costs further," they note.

Like most E&P firms, the stock carries a high uncertainty rating, given how vulnerable its profitability is to natural gas prices.

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.