Morningstar Grades and ETFs: Tech and Healthcare Showing the Most Promise

There are many ways to evaluate companies using stock screening tools. Curiosity led me to screen for companies that received praise across a wide spectrum of Morningstar-specific grades.

Specifically, Morningstar offers ratings in the following areas:

1. Overall (1-5 stars): The highly coveted, 5-star stock or mutual fund grade reportedly considers a stock's estimate of fair value, risk level and economic moat rating. It follows that I screened for 5-star stocks exclusively.

2. Economic Moat: The idea of an economic moat refers to the probability that a corporation can stay one step ahead of competitors. Morningstar describes this as a rating of the strength and sustainability of a firm's competitive advantage. Naturally, I screened for the widest moat, best positioned companies.

3. Financial Health: In these troubled times, it seems sensible to investigate companies that receive better-than-average grades (A or B) for the health of their balance sheets. For this reason, alone I excluded all financial services firms.

4. Stewardship: The word itself implies how well the management team is running the corporation. However, Morningstar assigns its grades across a body of evidence, including: (a) whether management’s incentives are aligned with shareholders’ interests, (b) extent to which shareholders have a "say" and/or relationship with the higher-ups, and (c) transparency of business and accounting practices such that the public knows what the company is engaged in. Again, I screened for better-than-average grades (A or B) of stewardship.

A short list of 35 companies made the Morningstar cut. Names like Microsoft (MSFT), Monsanto (MON) and Wal-Mart (WMT) hardly surprised me.

Yet my main purpose for the screening was to see if any sectors/industries loomed large. If so, then one might wish to overweight an ETF portfolio in that direction. Conversely, one might wish to underweight segments that didn't seem to distinguish themselves.

Here was the breakdown:

Technology (7)
Health Care (5)
Consumer Services (5)
Transportation (4)
Industrials (3)
Consumer Discretionary (3)
Consumer Staples (2)
Energy (3)
Materials (2)
Misc (1)

Technology dominated the screen with 20% of the names. Some of the most familiar companies were present -- Microsoft, Intel (INTC), Cisco (CSCO), IBM (IBM). One of the best ways to get broad tech exposure would be through the SPDR Select Technology Fund (XLK) or the iShares DJ Technology Fund (IYW).

Healthcare appears on nearly every type of stock screen these days, whether you're looking to capitalize on the defensive nature of the sector, new drug pipelines, an aging boomer population or even the Obama infrastructure build-out vis-a-vis medical system upgrades. Broad health care exposure can be acquired with the SPDR Select Healthcare Fund (XLV) or the iShares DJ Healthcare Fund (IYH).

Consumer services rated surprisingly high, though this incorporated names like e-Bay, Lowe's and Sysco Food. There is a fund called the iShares DJ Consumer Services Fund (IYC), though I think it is far more subject to discretionary spending habits of wary consumers.

You might not be as intrigued by the energy, materials and utilities segments. Outside of a 5-star rating for Potash (POT), market leaders of the previous bull market do not seem to be rating well with the folks at Morningstar.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.