U.S. economic growth slowed to 2% in the third quarter as consumer spending stalled. A clogged supply chain and continued inflation have some concerned about growth in the fourth quarter and beyond--and what that means for stocks. Of course, Morningstar isn’t in the business of predicting where the stock market is headed. Still, equities have been in rally mode for much of 2021: The Morningstar U.S. Markets Index is up more than 20% for the year to date through the end of October. It’s not unreasonable to suggest that playing a little defense right now might be a good idea.
As such, we’re looking for some undervalued defensive stock ideas.
Specifically, we screened for the following.
Stocks in Morningstar’s Defensive Super Sector: This Super Sector includes industries that are relatively immune to economic cycles: healthcare, consumer defensive, and utilities. Companies in these sectors provide goods and services that we need in both good and bad times. If the economy slows, we’ll still fill our prescriptions, seek medical care, practice good hygiene, and enjoy our favourite beverages and snacks.
Stocks with wide or narrow Morningstar Economic Moat Ratings: Stocks that have durable competitive advantages, or economic moats, are by their very natures more reliable than no-moat companies in terms of their businesses. Moaty companies are financially healthy and highly profitable, two qualities that are prized when economic times get tough. And as Morningstar’s chief U.S. markets strategist David Sekera notes, stocks with moats are more likely to have the power to raise prices and pass through higher costs they may be experiencing.
Stocks trading at 4- and 5-star levels: Stocks at this rating level are significantly undervalued relative to our fair value estimates, providing a substantial margin of safety.
Stocks with low or medium Morningstar Uncertainty Ratings: In short, the uncertainty rating represents the predictability of a company's future cash flows. As such, we have a pretty high degree of confidence in our fair value estimates of companies with low and medium uncertainty ratings. (Long version: The uncertainty rating captures a range of likely potential intrinsic values for a company based on the characteristics of the business underlying the stock, including such things as operating and financial leverage, sales sensitivity to the economy, product concentration, and other factors. If the range of potential intrinsic values is narrow, the company earns a low uncertainty rating. If the range is great, the company earns a high uncertainty rating.)
Forty stocks made the cut.
