Top Scores Work Best Together

3/12/2012


Listed below are the most effective variables in our Quadrix rating system relative to the average stock in the Dow Jones U.S. Index. On average for the 230 rolling 12-month periods since 1992, the top one-fifth of stocks based on these variables outperformed the average stock in the index by the widest margin.

TOP QUADRIX VARIABLES
12-Mo. Relative Returns Since 1992
Average
(%)
Standard
Deviation
(%)
Return/
Standard
Deviation
Enterprise Value/EBITDA
4.8
9.7
0.49
Price/Sales to 5-Year Median
4.6
18.5
0.25
Price/Sales
4.4
16.0
0.27
L-T Expected Profit Growth
4.3
22.9
0.19
Price/Free Cash Flow
4.2
11.5
0.37

A quick glance at the list reveals that four of the top five variables — and three of the top three — are valuation ratios. Enterprise ratio (enterprise value/EBITDA) has been the best performer, with the highest and least-volatile relative returns. Enterprise value equals the sum of a company's stock-market value and debt, while EBITDA equals earnings before interest, taxes, depreciation, and amortization.

The enterprise ratio has delivered higher relative returns than our Quadrix Overall score or Quadrix Value score, so some may wonder why we don't ditch these composite scores and go with the single variable that has worked best. At least four reasons come to mind:

Past is not always prologue. Nothing says a top-performing variable will continue to work going forward. Indeed, the top one-fifth of stocks based on enterprise ratio has lagged in 15 of the last 17 rolling 12-month periods. By using several variables together, you can reduce the risk of selecting a variable just before it loses effectiveness.

CATEGORY SCORE PERFORMANCE
--------- Top One-Fifth Of Stocks Since 1992 Based On ---------
All
Stocks
Quality
Fin'l
Str.
Momen-
tum
Perfor-
mance
Overall
Value
Avg. return (%)
12.7
12.7
12.7
13.4
14.4
15.5
16.5
Stand. dev. (%)
21.4
20.5
19.1
22.5
23.5
20.2
26.9
Periods with up returns
178
179
180
173
175
189
178
Periods w/down returns
52
51
50
57
55
41
52

In general, you can reduce portfolio volatility by combining several variables. Enterprise ratio has delivered truly outstanding results since 1992, but only three of the 21 Value variables can match the Value score based on the ratio of relative return to relative volatility. Similarly, the Overall score, based on a weighted average of the Value score and the other five Quadrix category scores, has led to much less volatile relative returns than the Value score. 

Relative returns are not the only way to measure effectiveness. In 12-month periods since 1992, the Value score has worked best when the market rose, while the Overall score has worked best in down periods. As a result, top Overall scorers compare more favorably on absolute returns than on relative returns. The top one-fifth of stocks on Overall score has gained in 82% of the 12-month periods since 1992, versus 77% for all stocks, and for top Value scorers.

Overall scores are working nicely. Top Overall scorers have outperformed in nine consecutive 12-month periods.

Conclusion

While it makes sense to pay extra attention to stocks with low enterprise ratios and high Value scores, your odds of success will improve if you also insist on high Overall scores. Listed below are stocks with low enterprise ratios and high scores for Value and Overall. With the Dow Theory bullish, quality stocks available at reasonable valuations, and our Quadrix rating system working, we are comfortable with a mostly invested posture. Our buy lists have about 90% in stocks.  

STOCKS WITH LOW ENTERPRISE RATIOS
Ent. Value/
EBITDA
------------- Quadrix Scores -------------
Company (Price; Ticker)
Ratio
%
Rank
Momen-
tum
Value
Quality
Overall
Chevron ($109; CVX)
4.04
90
65
85
77
88
CF Industries ($169; CF) 
4.04
90
89
92
100
100
Aetna ($46; AET)
4.77
86
81
89
85
99
DISH Network ($30; DISH)
5.15
83
67
78
82
93
Intel ($27; INTC)
5.56
80
50
82
95
95
KLA-Tencor ($47; KLAC) 
5.75
78
71
84
94
98
Jabil Circuit ($25; JBL) 
5.99
76
66
85
78
96
UnitedHealth ($54; UNH) 
6.21
74
52
71
84
90
Macy's ($37; M) 
6.38
72
69
76
59
91
DirecTV ($46; DTV)
6.49
71
75
87
97
94
Cisco Systems ($19; CSCO) 
6.57
70
87
83
69
97
Note: Quadrix scores are percentile ranks, with 100 the best.

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