Stock report from Morningstar

1. ?
Merck & Co Inc MRK [NYSE] | QQQQ
TM
Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic Moat Stewardship Morningstar Credit Rating Industry
38.56 USD 46.00 USD 32.20 USD 62.10 USD Medium Wide C AA Drug Manufacturers - Major
Merck Reports In-Line 4Q as Steady Growth From Key Drugs sales, operating costs fell about 100 basis points year over
year. We expect operating efficiencies will improve
Offsets Remicade and Vytorin Declines through 2012, but the loss of high-margin Singulair this
year is likely to cause overall operating margins to decline
by Damien Conover, CFA
Analyst Note Feb. 02, 2012 for the full year.
Associate Director
Analysts covering this company do not Merck reported fourth-quarter results that largely
own its stock.
matched our expectations, and we don’t expect any
Thesis Oct. 19, 2011
Pricing data through February 17, 2012. changes to our fair value estimate. Total sales increased
Rating updated as of
2% from the prior-year period with strength across the Facing increased competition, patent losses, and a
February 17, 2012.
majority of Merck’s key products, excluding weakness pipeline of late-stage drugs with poor chances of
Currency amounts expressed with "$" from cardiovascular drug Vytorin and lower sales from approval, Merck greatly improved its long-term outlook by
are in U.S. dollars (USD) unless
immunology drug Remicade because of partial drug rights acquiring Schering-Plough. Without Schering, Merck’s
otherwise denoted.
returned to Johnson & Johnson. Earnings per share prospects were muddled, despite its recent success
Stock Price increased 10% year over year as lower research and launching several new blockbusters. Now, with the
44.0 addition of Schering, we believe Merck is favorably
development costs helped fuel growth. Merck issued 2012
EPS guidance of $3.75-$3.85, which we believe it will positioned for long-term growth.
meet, but likely on the low end of the range.
34.0 Merck’s new products during the last few years have
The majority of Merck’s products posted steady gains in helped to offset recent patent losses. Januvia for
the quarter, which helped to offset declines in Remicade diabetes, Isentress for HIV, and the Gardasil vaccine
and Vytorin. This trend should continue through the first against human papillomavirus represent new
24.0
half of the year, but the August U.S. patent loss on blockbusters. All the drugs enjoyed monopoly positions at
08 09 10 11 12
respiratory drug Singulair will create a major headwind as the time of launch. However, current and expected
the drug represents more than 10% of the company’s total competition from other big drug firms likely will create a
sales. Rapidly growing drugs such as diabetes medicines drag on these drugs’ growth during the next few years.
Januvia and Janumet along with HIV drug Isentress
should help mitigate the loss of Singulair, but we expect a Still reeling from the patent loss on hypertension drugs
single-digit negative growth rate in 2012. Over the longer Cozaar/Hyzaar in early 2010, Merck faces the loss of its
term, we expect Merck to return to growth as patent next top drug in terms of revenue generation: Singulair for
losses are less significant after 2012 and the company is respiratory ailments in 2012. Singulair represents more
poised to launch several new pipeline products. We than 10% of the combined sales of Merck and Schering.
believe the most underappreciated pipeline products While losses in international markets should not fade as
include sugammadex for anesthesia and an mTor inhibitor fast as in U.S. markets, the patent expirations create
for cancer. Additionally, while off to a relatively slow major roadblocks to Merck’s growth.
start, recently launched hepatitis C drug Victrelis
generated $87 million in the quarter. Based on solid Merck’s efforts to develop a reliable late-stage pipeline
efficacy and a likely willingness to price competitively in have yielded questionable results. The Food and Drug
cost-sensitive markets, we expect the drug will develop Administration denied Merck approval for cholesterol drug
into a blockbuster. Tredaptive (formerly Cordaptive) in early 2008.
Subsequently, Merck reported poor clinical data on
Lower research and development expenses offset late-stage drugs Rolofylline for heart disease and
increased marketing and administrate costs, lifting EPS Telcagepant for migraines. Further, key late-stage drug
growth faster than sales growth. As percentage of total anacetrapib for atherosclerosis is chemically extremely

2. Merck & Co Inc MRK [NYSE] | QQQQ
TM
Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic Moat Stewardship Morningstar Credit Rating Industry
38.56 USD 46.00 USD 32.20 USD 62.10 USD Medium Wide C AA Drug Manufacturers - Major
Risk
Close Competitors Currency(Mil) Market Cap TTM Sales Oper Income Net Income
Merck’s near-term risk largely centers on market
Merck & Co Inc USD 117,528 47,847 5,646 4,228
acceptance of new products. Like all pharmaceutical
Pfizer Inc USD 162,887 68,785 11,402 11,460
companies, Merck faces regulatory risk from the FDA.
Eli Lilly and Company USD 45,454 24,427 5,909 4,659
Product delays or nonapprovals could hurt the stock. Also,
the growing power of managed care and a more
Morningstar data as of February 17, 2012. price-sensitive U.S. government may reduce Merck’s
similar to a drug (torcetrapib) that failed to receive FDA pricing power. Additionally, Merck faces some remaining
approval, raising the risk that anacetrapib might meet the legal risk with Vioxx. While the majority of plaintiffs
same end. participated in the $4.85 billion settlement, a few holdouts
could ring up major additional settlements.
Deciding not to wait for new internal pipeline drugs,
Merck significantly strengthened its operations by
Bulls Say
acquiring Schering-Plough for about $40 billion. Schering
brings in a very strong pipeline of late-stage drugs with New product launches of Isentress and Januvia leaped
blockbuster potential and faces only limited patent losses to a strong start, and delays of competing drugs have
during the next few years. Combining the two entities given Merck a leg up in maintaining market
should also yield more than $3 billion in annual cost leadership.
savings by 2011. While Merck has historically chosen to Restructuring efforts should reduce costs and improve
grow through internal development, we believe the margins over the long term, helping to offset the patent
Schering acquisition places Merck in a stronger strategic expirations of high-margin products.
position. The acquisition of Schering enables Merck to
potentially achieve $3.5 billion in annual cost-saving
synergies by 2011.
Valuation, Growth and Profitability Merck’s bottom-up sales and marketing approach gives
We’re maintaining our fair value estimate of $46 per the salesforce autonomy to tailor sales calls and should
share. We believe Merck’s acquisition of Schering-Plough better service doctors and reduce operating costs.
will yield enough earnings growth to offset the steep The acquisition of Schering brings in a set of potential
purchase price. In particular, we expect several billion blockbuster new pipeline drugs, including hepatitis C
dollars in annual cost savings by 2011. Schering’s strong drug Victrelis and anesthesia treatment Bridion.
late-stage pipeline should boost Merck’s long-term growth
rate. On the patent side, Merck will face major generic
Bears Say
competition to its blockbuster drug Singulair in 2012.
Therefore, we anticipate a high degree of volatility in Merck faces the loss of its largest sales contributor
sales growth as the patent expires. However, we expect when the 2012 patent on Singulair expires.
sales of marketed products and products still under Poor trial results from a key Schering pipeline product
development eventually to offset sales lost to the called TRA casts a cloud of increased uncertainty over
Singulair patent expiration, and the addition of Schering’s the other pipeline products acquired in the Schering
pipeline further remedies Merck’s patent cliff. acquisition.
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß

3. Merck & Co Inc MRK [NYSE] | QQQQ
TM
Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic Moat Stewardship Morningstar Credit Rating Industry
38.56 USD 46.00 USD 32.20 USD 62.10 USD Medium Wide C AA Drug Manufacturers - Major
Poor results from the Enhance study combined with divisions should position him well to lead the company.
increased generic statin competition could reduce the Also, Frazier deserves much of the credit for the
market potential for Vytorin and Zetia. successful handling of the Vioxx litigation as he held
The lack of robust internal pipeline successes casts Merck’s general counsel position during the majority of
increased uncertainty over Merck’s once stellar the litigation. Merck announced the appointment of Peter
research and development credentials. Kellogg to the CFO post in June 2007. Kellogg filled the
The combining of Schering’s and Merck’s operations spot left vacant by Merck veteran Judy Lewent, who
will probably encounter several integration problems, announced her retirement in early 2007. Kellogg brings
which may delay and possibly negate some of the senior financial experience, as he was most recently the
high-cost synergies expected by the market. CFO for Biogen Idec BIIB. Merck’s board is packed with
current and retired CEOs, which can lead to quid pro quo
compensation packages for top executives but lends
Financial Overview valuable strategic-planning experience. Also,
Financial Health: Merck remains in strong financial health, Merck shifted from staggered to annual elections of its
even with the additional $8.5 billion in debt needed for the board members and empowers minority shareholders by
Schering acquisition. We expect the combined company allowing cumulative voting for board members.
will generate a free cash flow of approximately $12 billion
in 2011. Merck’s strong and stable cash flows should
whittle away the debt relatively quickly.
Company Overview
Profile: Merck makes pharmaceutical products to treat
conditions in a number of therapeutic areas, including
cardiovascular disease, asthma, infections, and
osteoporosis. The company also has a substantial vaccine
business, with treatments to prevent hepatitis B and
pediatric diseases as well as HPV and shingles. Following
the Schering acquisition, about 45% of the company’s
sales are generated in the United States.
Management: At the beginning of 2011, Ken Frazier took
over the helm of Merck as CEO from Dick Clark. With Clark
nearing the age of retirement, we view the new
leadership as a continuation of Merck s past strategy and
not a red flag causing concern. Also, Frazier will take over
the role of the chairman of the board for Merck in late
2011. Regarding the new CEO, Frazier s almost two
decades of experience at Merck across most major
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß

4. Merck & Co Inc MRK [NYSE] | QQQQ
TM
Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic Moat Stewardship Morningstar Credit Rating Industry
38.56 USD 46.00 USD 32.20 USD 62.10 USD Medium Wide C AA Drug Manufacturers - Major
Analyst Notes
Feb. 02, 2012 Merck Reports In-Line 4Q as Steady Growth From Key Drugs Offsets Remicade and Vytorin Declines
Merck reported fourth-quarter results that largely matched expect Merck to return to growth as patent losses are less
our expectations, and we don’t expect any changes to our significant after 2012 and the company is poised to launch
fair value estimate. Total sales increased 2% from the several new pipeline products. We believe the most
prior-year period with strength across the majority of underappreciated pipeline products include sugammadex
Merck’s key products, excluding weakness from for anesthesia and an mTor inhibitor for cancer.
cardiovascular drug Vytorin and lower sales from Additionally, while off to a relatively slow start, recently
immunology drug Remicade because of partial drug rights launched hepatitis C drug Victrelis generated $87 million in
returned to Johnson & Johnson. Earnings per share the quarter. Based on solid efficacy and a likely willingness
increased 10% year over year as lower research and to price competitively in cost-sensitive markets, we expect
development costs helped fuel growth. Merck issued 2012 the drug will develop into a blockbuster.
EPS guidance of $3.75-$3.85, which we believe it will meet,
but likely on the low end of the range. Lower research and development expenses offset increased
marketing and administrate costs, lifting EPS growth faster
The majority of Merck’s products posted steady gains in the than sales growth. As percentage of total sales, operating
quarter, which helped to offset declines in Remicade and costs fell about 100 basis points year over year. We expect
Vytorin. This trend should continue through the first half of operating efficiencies will improve through 2012, but the
the year, but the August U.S. patent loss on respiratory loss of high-margin Singulair this year is likely to cause
drug Singulair will create a major headwind as the drug overall operating margins to decline for the full year.
represents more than 10% of the company’s total sales.
Rapidly growing drugs such as diabetes medicines Januvia
and Janumet along with HIV drug Isentress should help
mitigate the loss of Singulair, but we expect a single-digit
negative growth rate in 2012. Over the longer term, we
Oct. 28, 2011 Merck Reports Strong 3Q Driven by Growth Across Product Portfolio and Lower R&D Costs
Merck reported strong third-quarter results that slightly will easily meet.
exceeded our expectations. However, we don’t expect a
change to our fair value estimate based on the minor Steady gains across the majority of Merck’s products
outperformance. Total sales increased 3% operationally supported overall growth in the quarter, offsetting declines
versus the prior-year period with broad strength across the in Remicade. While we expect this trend to continue
majority of Merck key products, with the exception of through the first half of next year, the August 2012 U.S.
declines from immunology drug Remicade due to partial patent loss on respiratory drug Singulair will create a
rights returned to Johnson & Johnson. Earnings per share significant headwind for the company as the drug
increased 11% year over year as lower research and represents more than 10% of the company’s total sales.
development costs helped fuel growth. Merck raised the While rapidly growing drugs such as diabetes medicines
lower end of its full-year guidance range by 1%, resulting in Januvia and Janumet along with HIV drug Isentress will
a new range of $3.72-$3.76, which we expect the company help mitigate the loss of Singulair, we view single-digit
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß

5. Merck & Co Inc MRK [NYSE] | QQQQ
TM
Last Price Fair Value Consider Buy Consider Sell Uncertainty Economic Moat Stewardship Morningstar Credit Rating Industry
38.56 USD 46.00 USD 32.20 USD 62.10 USD Medium Wide C AA Drug Manufacturers - Major
Analyst Notes (continued)
negative growth in 2012 as very likely. Beyond 2012, we Lower research and development expenses offset an
expect Merck to return to growth as its patent exposure increased tax rate, boosting EPS growth faster than sales
decreases significantly and several new pipeline products growth. As percentage of total sales, operating costs fell
should launch. We believe the most underappreciated 200 basis points year over year as the company increased
pipeline products include sugammadex for anesthesia and productivity in research and development, partly related to
an mTor inhibitor for cancer. Further, while it’s off to a slow cost synergies from the Schering-Plough acquisition. We
start, we expect hepatitis C drug Victrelis will eventually expect these efficiencies will continue into 2012, but the
develop into a blockbuster based on strong efficacy, loss of high-margin Singulair in 2012 is likely to cause
powerful marketing support, and a likely willingness to overall operating margins to fall more than 100 basis points
price competitively in cost-sensitive areas of the market. next year.
Disclaimers & Disclosures
No Morningstar employees are officers or directors of this company. Morningstar Inc. does not own more than 1% of the shares of this company. Analysts
covering this company do not own its stock. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely.
This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß

6. Morningstar ® Stock Data Sheet Pricing data thru Feb. 17, 2012 Rating updated as of Feb. 17, 2012 Fiscal year-end: December
Merck & Co Inc MRK Sales USD Mil Mkt Cap USD Mil Industry
47,847 117,528 Drug Healthcare
Sector
Manufacturers - Major
Merck makes pharmaceutical products to treat conditions in Morningstar Rating Last Price Fair Value Uncertainty Economic Moat
TM
Stewardship Grade
a number of therapeutic areas, including cardiovascular QQQQ 38.56 46.00 Medium Wide C
disease, asthma, infections, and osteoporosis. The company per share prices in USD
also has a substantial vaccine business, with treatments to 61.02 60.08 49.33 35.36 46.37 61.62 61.18 38.42 41.56 37.90 39.43 Annual Price High
prevent hepatitis B and pediatric diseases as well as HPV 36.50 40.57 25.60 25.50 31.81 42.35 22.82 20.05 30.70 29.47 37.70 Low
Recent Splits
and shingles. Following the Schering acquisition, about 45%
Price Volatility
of the company’s sales are generated in the United States. Monthly High/Low
39.0
Rel Strength to S&P 500
52 week High/Low
19.0 39.43 - 29.47
10 Year High/Low
61.62 - 20.05
6.0 Bear-Market Rank
One Merck Drive 7 (10=worst)
Whitehouse Station, NJ 08889-0100 3.0
Trading Volume Million
Phone: 1 908 423-1000Website: http://www.merck.com 14.0
8.0
Growth Rates Compound Annual 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 YTD Stock Performance
Grade: C 1 Yr 3 Yr 5 Yr 10 Yr -2.5 -11.3 -27.4 3.7 41.8 36.8 -45.1 25.2 2.8 8.9 2.3 Total Return %
Revenue % 67.7 23.9 15.9 1.3 20.9 -37.7 -36.4 0.7 28.2 33.3 -6.6 1.8 -10.0 8.9 -5.9 +/- Market
Operating Income % -0.7 -23.5 -15.6 -12.6 16.1 -27.0 -23.2 1.4 27.6 33.4 -27.7 9.9 -0.5 -6.6 1.4 +/- Industry
Earnings/Share % -95.0 -42.7 -33.2 -20.9 2.5 3.2 4.3 4.8 3.5 2.6 5.0 4.2 4.2 4.1 4.0 Dividend Yield %
Dividends % 0.0 0.0 0.0 1.9
120606 102795 71273 69557 94656 126480 64271 113574 111079 114907 117528 Market Cap USD Mil
Book Value/Share % -7.2 28.3 16.6 10.6
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 TTM Financials
Stock Total Return % 21.2 14.7 0.8 -0.5
47716 51790 22486 22939 22012 22636 24198 23850 27428 45987 47847 Revenue USD Mil
+/- Industry 7.0 -0.5 -2.0 -2.7
39.3 36.2 80.8 78.4 76.6 73.5 74.6 76.6 67.1 60.0 64.2 Gross Margin %
+/- Market 19.6 -5.2 2.1 -2.0
9728 9668 8355 6622 5537 3544 5290 5053 2387 2370 5646 Oper Income USD Mil
Profitability Analysis 20.4 18.7 37.2 28.9 25.2 15.7 21.9 21.2 8.7 5.2 11.8 Operating Margin %
Grade: D Current 5 Yr Avg Ind Mkt 7282 7150 6831 5813 4631 4434 3275 7808 12899 859 4228 Net Income USD Mil
Return on Equity % 7.6 24.1 18.7 22.6 . 3.14 3.03 2.61 2.10 2.03 1.49 3.64 5.65 0.28 1.36 Earnings Per Share USD
Return on Assets % 3.9 10.1 8.7 9.5 1.42 1.46 1.39 1.52 1.52 1.52 1.52 1.52 1.52 1.52 Dividends USD
.
Fixed Asset Turns 2.9 2.0 3.8 7.5 2277 2253 2226 2200 2188 2193 2145 2273 3120 3104 Shares Mil
.
Inventory Turns 2.7 2.8 2.7 16.1 8.11 7.00 7.80 8.19 8.09 8.35 8.87 19.00 17.64 18.09 18.09 Book Value Per Share USD
Revenue/Employee USD K 509.0 398.5 * . 1048.4
9080 9529 9862 8799 7609 6765 6999 6572 3392 10822 12689 Oper Cash Flow USD Mil
Gross Margin % 64.2 70.4 71.6 38.3 -2725 -2370 -1916 -1726 -1403 -980 -1011 -1298 -1461 -1678 -1780 Cap Spending USD Mil
Operating Margin % 11.8 14.5 22.5 16.7 6355 7159 7947 7073 6206 5785 5988 5273 1931 9144 10909 Free Cash Flow USD Mil
Net Margin % 8.8 22.9 16.5 11.2
Free Cash Flow/Rev % 22.8 19.9 21.5 0.1 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 TTM Profitability
R&D/Rev % 21.9 0.2 . 9.7 . 15.6 15.5 14.0 10.6 9.9 7.0 16.3 16.2 0.8 3.9 Return on Assets %
. 41.8 40.5 35.4 26.3 25.0 18.3 42.3 33.1 1.5 7.6 Return on Equity %
Financial Position 15.3 13.8 30.4 25.3 21.0 19.6 13.5 32.7 47.0 1.9 8.8 Net Margin %
Grade: A 12-10 USD Mil 09-11 USD Mil
. 1.13 0.51 0.55 0.50 0.51 0.52 0.50 0.34 0.42 0.45 Asset Turnover
Cash 10900 14253 . 2.6 2.6 2.5 2.5 2.5 2.7 2.5 1.9 2.0 1.9 Financial Leverage
Inventories 5868 6239
Receivables 7344 8136 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 09-11 Financial Health
Current Assets 29064 34109 1417 2459 1958 1731 7746 2508 2787 4986 12678 13423 17516 Working Capital USD Mil
4799 4879 5096 4692 5126 5551 3916 3943 16075 15482 15692 Long-Term Debt USD Mil
Fixed Assets 17082 16383
16050 18201 15576 17288 17917 17560 18185 18758 59058 54376 55140 Total Equity USD Mil
Intangibles 51834 48050
. 0.27 0.33 0.27 0.29 0.32 0.22 0.21 0.27 0.28 0.28 Debt/Equity
Total Assets 105781 106534
Payables 4727 4910 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 TTM Valuation
Short-Term Debt 2400 2455 18.1 15.8 12.3 15.2 21.5 39.1 8.3 6.5 128.2 27.7 28.3 Price/Earnings
Current Liabilities 15641 16593 . . . . . . . . . 1.6 1.9 P/E vs. Market
Long-Term Debt 15482 15692 2.5 4.6 3.1 3.2 4.2 5.3 2.7 3.0 2.4 2.5 2.5 Price/Sales
Total Liabilities 51405 51394 7.0 6.6 4.1 3.9 5.4 7.0 3.4 1.9 2.0 2.1 2.1 Price/Book
13.6 10.6 8.1 9.2 14.1 18.2 9.9 24.5 10.4 9.2 9.4 Price/Cash Flow
Total Equity 54376 55140
Valuation Analysis Quarterly Results Industry Peers by Market Cap
Current 5 Yr Avg Ind Mkt Revenue USD Mil Dec 10 Mar 11 Jun 11 Sep 11 Mkt Cap USD Mil Rev USD Mil P/E ROE%
Price/Earnings 28.3 42.0 15.7 14.8 Most Recent Period 12093.7 11580.0 12151.0 12022.0 Merck & Co Inc 117528 47847 28.3 7.6
Forward P/E 10.3 . . 13.4 Prior Year Period 10093.5 11422.2 11346.3 11124.9 Pfizer Inc 162887 68785 16.6 12.9
Price/Cash Flow 9.4 14.4 10.0 7.5 Rev Growth % Dec 10 Mar 11 Jun 11 Sep 11 Eli Lilly and Compan 45454 24427 9.4 33.7
Price/Free Cash Flow 11.0 19.9 11.8 17.2
Most Recent Period 19.8 1.4 7.1 8.1
Dividend Yield % 4.0 . 3.7 2.0 Major Fund Holders
Prior Year Period 67.3 112.1 92.3 83.9
Price/Book 2.1 3.3 2.8 2.0 % of shares
Price/Sales 2.5 3.2 2.5 1.2 Earnings Per Share USD Dec 10 Mar 11 Jun 11 Sep 11 .
PEG Ratio 2.1 . . 1.5 Most Recent Period -0.17 0.34 0.65 0.55 .
Prior Year Period 2.62 0.09 0.24 0.11 .
*3Yr Avg data is displayed in place of 5Yr Avg TTM data based on rolling quarterly data if available; otherwise most recent annual data shown.
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß

7. Morningstar’s Approach to Rating Stocks
Our Key Investing Concepts
TM
At Morningstar, we evaluate stocks as pieces of a just on movement in the share price. If we think a stock’s
Economic Moat Rating
business, not as pieces of paper. We think that purchasing fair value is $50, and the shares decline to $40 without
Discounted Cash Flow
Discount Rate shares of superior businesses at discounts to their much change in the value of the business, the star rating
Fair Value intrinsic value and allowing them to compound their value will go up. Our estimate of what the business is worth
Uncertainty over long periods of time is the surest way to create hasn’t changed, but the shares are more attractive as an
Margin of Safety
Consider Buying/Consider Selling wealth in the stock market. investment at $40 than they were at $50.
Stewardship Grades
We rate stocks 1 through 5 stars, with 5 the best and 1 Because we focus on the long-term value of businesses,
the worst. Our star rating is based on our analyst’s rather than short-term movements in stock prices, at times
estimate of how much a company’s business is worth per we may appear out of step with the overall stock market.
share. Our analysts arrive at this "fair value estimate" by When stocks are high, relatively few will receive our
forecasting how much excess cash--or "free cash highest rating of 5 stars. But when the market tumbles,
flow"--the firm will generate in the future, and then many more will likely garner 5 stars. Although you might
adjusting the total for timing and risk. Cash generated expect to see more 5-star stocks as the market rises, we
next year is worth more than cash generated several years find assets more attractive when they’re cheap.
down the road, and cash from a stable and consistently
profitable business is worth more than cash from a We calculate our star ratings nightly after the markets
cyclical or unsteady business. close, and issue them the following business day, which is
why the rating date on our reports will always be the
Stocks trading at meaningful discounts to our fair value previous business day. We update the text of our reports
estimates will receive high star ratings. For high-quality as new information becomes available, usually about once
businesses, we require a smaller discount than for or twice per quarter. That is why you’ll see two dates on
mediocre ones, for a simple reason: We have more every Morningstar stock report. Of course, we monitor
confidence in our cash-flow forecasts for strong market events and all of our stocks every business day, so
companies, and thus in our value estimates. If a stock’s our ratings always reflect our analyst’s current opinion.
market price is significantly above our fair value estimate,
it will receive a low star rating, no matter how wonderful
TM
we think the business is. Even the best company is a bad Economic Moat Rating
TM
deal if an investor overpays for its shares. The Economic Moat Rating is our assessment of a firm’s
ability to earn returns consistently above its cost of capital
Our fair value estimates don’t change very often, but in the future, usually by virtue of some competitive
market prices do. So, a stock may gain or lose stars based advantage. Competition tends to drive down such
Morningstar Research
Methodology for Valuing Competitive Economic Company Fair Value Uncertainty
Companies Analysis
TM
Moat Rating Valuation Estimate Assessment QQQQQ
Analyst conducts The depth of the Analyst considers DCF model leads to An uncertainty Q The current stock
company and industry firm’s competitive company financial the firm’s Fair Value assessment QQ price relative to fair
research: advantage is rated: statements and Estimate, which establishes the QQQ value, adjusted
competitive position anchors the rating margin of QQQQ for uncertainty,
Management None to forecast future framework. safety required for QQQQQ determines the
interviews Narrow cash flows. the stock rating. rating.
Conference calls Wide
Trade-show visits Assumptions are
Competitor, supplier, input into a dis-
distributor, and counted cash-flow
customer interviews model.
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
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8. Morningstar’s Approach to Rating Stocks (continued)
economic profits, but companies that can earn them for an Very High, or Extreme. The greater the level of uncertainty,
extended time by creating a competitive advantage the greater the discount to fair value required before a
possess an Economic Moat. We see these companies as stock can earn 5 stars, and the greater the premium to fair
superior investments. value before a stock earns a 1-star rating.
Discounted Cash Flow Margin of Safety
This is a method for valuing companies that involves This is the discount to fair value we would require before
projecting the amount of cash a business will generate in recommending a stock. We think it’s always prudent to
the future, subtracting the amount of cash that the buy stocks for less than they’re worth.The margin of safety
company will need to reinvest in its business, and using is like an insurance policy that protects investors from bad
the result to calculate the worth of the firm. We use this news or overly optimistic fair value estimates. We require
technique to value nearly all of the companies we cover. larger margins of safety for less predictable stocks, and
smaller margins of safety for more predictable stocks.
Discount Rate
We use this number to adjust the value of our forecasted Consider Buying/Consider Selling
cash flows for the risk that they may not materialize. For a The consider buying price is the price at which a stock
profitable company in a steady line of business, we’ll use would be rated 5 stars, and thus the point at which we
a lower discount rate, also known as "cost of capital," would consider the stock an extremely attractive
than for a firm in a cyclical business with fierce purchase. Conversely, consider selling is the price at
competition, since there’s less risk clouding the firm’s which a stock would have a 1 star rating, at which point
future. we’d consider the stock overvalued, with low expected
returns relative to its risk.
Fair Value
This is the output of our discounted cash-flow valuation Stewardship Grades
models, and is our per-share estimate of a company’s We evaluate the commitment to shareholders
intrinsic worth. We adjust our fair values for off-balance demonstrated by each firm’s board and management team
sheet liabilities or assets that a firm might have--for by assessing transparency, shareholder friendliness,
example, we deduct from a company’s fair value if it has incentives, and ownership. We aim to identify firms that
issued a lot of stock options or has an under-funded provide investors with insufficient or potentially
pension plan. Our fair value estimate differs from a "target misleading financial information, seek to limit the power
price" in two ways. First, it’s an estimate of what the of minority shareholders, allow management to abuse its
business is worth, whereas a price target typically reflects position, or which have management incentives that are
what other investors may pay for the stock. Second, it’s a not aligned with the interests of long-term shareholders.
long-term estimate, whereas price targets generally focus The grades are assigned on an absolute scale--not relative
on the next two to 12 months. to peers--and can be interpreted as follows: A means
"Excellent," B means "Good," C means "Fair," D means
"Poor," and F means "Very Poor."
Uncertainty
To generate the Morningstar Uncertainty Rating, analysts
consider factors such as sales predictability, operating
leverage, and financial leverage. Analysts then classify
their ability to bound the fair value estimate for the stock
into one of several uncertainty levels: Low, Medium, High,
© 2012 Morningstar. All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. Data as originally reported. ®
The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security.
Redistribution is prohibited without written permission. To order reprints, call +1 312-696-6100. To license the research, call +1 312-696-6869.
ß