Going For Growth

3/26/2012


Growth and value stocks have been engaged in a tug of war for generations. For the last 10 years, they've been evenly matched. But over the last 12 months, growth is winning.

The S&P 500 Growth Index returned 9% in the year ended February, versus 2% for the S&P 500 Value Index. Both indexes have delivered annualized total returns of about 3% over the last decade.

Buying shares of companies with the fastest-rising profits can be a winning strategy. But it doesn't work all the time, as the table below illustrates.

GOOD GROWERS OUTPERFORM
The effectiveness of growth factors tends to vary over time. Over the last 12 rolling 12-month periods, the top quintile (one-fifth) of the S&P 1500 Index as measured by sales growth in the last quarter averaged 12-month returns 1.0% above those of the average stock in the index. Top sales growers lagged in the previous four 12-month periods ended February.
------------ Average Outperformance Of Top Quintile Based On ------------
Selection Date
EPS
Change,
Last
Quarter
(%)
Sales
Change,
Last
Quarter
(%)
EPS
Change,
Last
Year
(%)
L-T
Expected
Profit
Growth
(%)
EPS
Revisions,
Current
Quarter
(%)
12 Mos. Ended 2/12
(0.3)
1.0
(3.8)
3.7
4.1
12 Mos. Ended 2/11
(3.2)
(4.1)
(3.3)
2.5
(1.5)
12 Mos. Ended 2/10
(5.5)
(2.2)
(1.9)
2.7
(7.0)
12 Mos. Ended 2/09
(2.6)
(2.5)
(1.3)
1.0
2.7
12 Mos. Ended 2/08
1.2
(0.2)
3.7
3.6
0.7
12 Mos. Ended 2/07
2.8
1.4
3.6
(2.7)
1.3
12 Mos. Ended 2/06
1.5
3.4
3.0
(1.3)
4.7
12 Mos. Ended 2/05
0.5
0.3
1.9
5.6
2.5

Top-scoring stocks based on sales and profit growth in the most recent quarter outperformed for most of the four years before the 2008 market meltdown. They have not worked as well since then, though the last 18 months have been somewhat friendlier. These factors swing in and out of favor from year to year — and sometimes from month to month. However, the S&P 500 Growth Index tends to outperform the S&P 500 Value Index when those growth metrics are working.

Of course, recent operating momentum is not the only way to identify growth stocks. Stocks with high profit-growth expectations have outperformed in recent years. Over the last five years, the top one-fifth of the S&P 1500 as measured by long-term expected profit growth outperformed the average stock by an average of 2.7%, based on 12-month returns. Profit-estimate revisions, another commonly tracked growth factor, have enjoyed excellent predictive power over most of the last 15 years, though their effectiveness can also change swiftly. After a nearly two-year slump, companies that rate the highest based on the ratio of positive revisions to negative revisions have outperformed the average stock by an average of 4.1% in the last 12 rolling 12-month periods.

The up-and-down effectiveness of growth factors makes it tough to predict which ones are likely to work best over the next year. We prefer to hedge our bets and find stocks that look good from several directions. 

The search for growth

At the moment, investors have little trouble finding stocks with solid sales and profit growth or estimated future growth. As of the end of February, 753 components of the S&P 1500 Index had delivered at least 10% year-to-year sales growth in their most recent 12-month period, about 15% above the average of 654 companies since the end of 1994. Current totals for stocks with 10% sales growth over the last quarter are also above long-term norms. About 991 companies have expected long-term profit growth of at least 10%, versus the long-run average of 902 companies.

But while operating momentum is plentiful, earnings revisions are another matter. The S&P 500 Index's earnings estimates have trended lower for at least nine months, as shown in the table below. From the end of June 2011 through March 16, the consensus profit estimate for the index's March 2012 quarter fell 10%. The June-quarter consensus dipped 7%, and the full-year consensus 6%. The consensus for the index currently projects per-share-profit growth of 8% this year and 13% in 2013.

PROFIT ESTIMATES DOWN
While consensus profit estimates for the S&P 500 Index have inched upward over the last couple weeks, they have been trending downward for most of the last nine months.
---- S&P 500 Index Consensus Per-Share-Profit Estimate ----
Date Of Estimate
March 2012
Quarter
($)
June 2012
Quarter
(%)
Full-Year
2012
($)
Full-Year
2013
($)
March 16
23.95
26.12
105.89
119.20
End of December
24.87
26.62
107.30
119.63
End of September
26.07
27.72
110.92
123.19
End of June
26.65
28.04
113.14
124.56
Source: Thomson Reuters.

Only 34% of S&P 1500 stocks have seen the profit consensus for their current quarter rise over the last 30 days. For the average S&P 1500 stock, the consensus projects per-share-profit growth of 3% this quarter and 5% next quarter, with growth picking up in the second half of the year, then jumping to 17% in 2013.

Market trend or not, when we look for growth stocks, we want it all. To that end, we screened for companies with appeal based on recent growth, expected growth, and estimate-revision trends. This screen weeded out the growth wannabes.

Don't forget value

Can we be sure that stocks with strong recent growth will outperform in coming years? No, we cannot. Fortunately, we can improve our odds by incorporating value without compromising on growth.

As of March 20, 250 S&P 1500 components had grown profits at least 10% over the last year and still traded at no more than 15 times trailing earnings. That selection of stocks is in line with the norm since 1994, leaving us plenty of potential winners.

The availability of many bona fide growth stocks trading at attractive valuations is just one reason we advise subscribers to remain mostly invested. At the moment, with the Dow Theory still bullish, our buy lists have about 90% in stocks and 10% in a short-term bond fund. Listed below are genuine growth stocks with P/E ratios of 15 or less.

BONA FIDE GROWERS AT VALUE PRICES
All nine of the A-rated stocks below generated double-digit profit growth over the last 12 months. Profit estimates for the next two quarters and the next two years have not declined over the last 30 days, and all nine are expected to deliver at least 8% profit growth this year and next year. This growth comes at a reasonable price — no more than 15 times trailing earnings. Stocks recommended for purchase are listed in bold.
EPS
Growth.
Last 12
Months
(%)
Estimated EPS Growth
Trailing
P/E Ratio
Company (Price; Ticker)
Current
Year
(%)
Next
Year
(%)
Caterpillar ($111; CAT)
80
18
22
14
Cisco Systems ($21; CSCO)
11
8
13
12
Dover ($63; DOV)
23
12
15
14
IBM ($204; IBM)
15
10
11
15
Jabil Circuit ($26; JBL)
34
13
10
11
Macy's ($40; M)
35
13
16
14
U.S. Bancorp ($32; USB)
37
10
12
13
Valero Energy ($27; VLO)
146
13
12
7
Wells Fargo ($34; WFC)
23
13
13
12
Note: Quadrix scores are percentile ranks, with 100 the best.

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