Keep Driving For Bargains

4/2/2012


Money, like water or highway traffic, flows toward the path of least resistance. For most investors that means buying shares of "good" companies, even though history suggests that getting a good price is even more important. Our Quadrix Value score can help you capitalize on this tendency, allowing you to switch lanes ahead of the crowd by moving into undervalued stocks.

In rolling 12-month periods since 1994, stocks scoring above 80 in Value have outperformed the average S&P 1500 Index stock by an average of 2.9% — more than any of the other Quadrix category scores and even the Overall rank. Value has also been the top Quadrix category score in the last five- and 10-year periods. And historically, among stocks scoring above 80 in Value, the higher the score, the higher the 12-month return.

Value in a slump

The Value score has not worked well in the past 12 rolling 12-month periods. Given an abundance of cheap stocks and doubt's regarding the global economy, investors have migrated toward companies with a history of growing sales, profits, and dividends. Stocks scoring in the top one-fifth for Quality have topped the average S&P 1500 stock by an average of 5.9% in those 12 periods.

Still, it is hard to argue with Value's long-term success. The score considers a number of valuation ratios, and some of the best predictors of outperformance are shown in the table below. For example, the price/sales ratio — and that same ratio relative to the five-year median — consistently rank among the most effective Value factors. Over the last 12 rolling 12-month periods, the price/cash flow ratio worked better than any other Value factor. It was the only Value variable for which the top quintile outperformed the average stock, if only by a narrow margin (0.1%).

VALUATION RATIOS TELL TALE

In rolling 12-month periods since 1994, the top one-fifth of stocks in the S&P 1500 Index as measured by Quadrix Value scores outperformed the average stock in three of the four periods listed below. For example, the top one-fifth of stocks as measured by Value score outperformed the average stock by an average of 2.9% since 1994. Earnings Estimates scores, first calculated in 2004, are omitted.

The bottom table lists the average outperformance of the 12 Value factors most effective since 1994. Several factors, which are sorted by long-term outperformance, are consistently effective. Notable statistics include price/sales to five-year median, enterprise value/EBITDA, and price/sales.

Average Outperformance Of
---------- Top One-Fifth Of S&P 1500 ----------
Last 12
Months
(%)
Last 5
Years
(%)
Last 10
Years
(%)
Since
1994
(%)
Overall and category scores
Overall
2.6
(0.4)
1.5
2.7
Value
(1.8)
2.1
3.6
2.9
Quality
5.9
1.3
(0.4)
0.7
Momentum
2.3
(1.2)
0.9
0.6
Financial Strength
0.2
(0.6)
(1.6)
(0.3)
Performance
(0.3)
(4.9)
(2.6)
(0.3)
Value factors
Price/sales to 5-year median
(4.5)
5.3
4.7
4.1
Enterprise value/EBITDA
(0.7)
2.8
4.9
4.1
Price/book
(4.6)
2.2
4.7
3.8
Price/free cash flow
(4.5)
0.0
2.2
3.4
Price/sales
(3.2)
4.3
5.8
3.3
Price/sales to 3-year median
(4.3)
5.1
4.0
3.2
Price/earnings
(1.9)
1.3
3.0
3.1
Price/cash flow
0.1
3.5
4.5
3.0
Price/book to 5-year median
(3.5)
3.9
3.0
2.4
Price/cash flow to 5-year median
(2.6)
2.6
1.6
1.9
Price/book to 3-year median
(3.4)
4.7
2.7
1.9
Price/earnings to 5-year median
(2.5)
3.0
1.9
1.6

The returns of portfolios created using valuation ratios involving sales and cash flow tend to be less volatile than portfolios of stocks with the lowest price/earnings ratios. Cost cuts can temporarily buoy profits in the absence of operating momentum, and companies frequently exclude charges from earnings. Sometimes sales and cash flow may offer a clearer gauge of a company's performance.

While high Value scorers tend to outperform, we advise investors not to simply scoop up all the cheapest stocks. Many value stocks become cheap because bad news drove the price down. Some of those stocks recover nicely. But others keep falling and only get cheaper, as has been the case with Research In Motion ($14; RIMM) and its crumbling business.

The Forecasts has long favored stocks with attractive valuations. But we don't buy blindly. We analyze the fundamentals and outlook — checking both the rearview mirror and the road signs ahead for a stock — before changing lanes. Below, we review three cheap stocks with strong business positions.

Aetna ($47; AET) scores in the top 20% of our research universe for four key Value factors, including price/sales (most effective for predicting outperformance over the last decade) and enterprise value/EBITDA (one of the top two factors since 1994). At nine times trailing earnings, shares trade 13% below their five-year average and 20% below the median for managed-care stocks in the S&P 1500.

The economic downturn has led many to postpone elective surgeries and diagnostic tests. Historically low medical-utilization rates helped Aetna grow free cash flow 78% to a record $1.97 billion in 2011. According to one survey of major U.S. markets, utilization rates are creeping higher in early 2012. Aetna appears ready for an uptick, already pricing new and renewal business in anticipation of a return to more traditional utilization levels this year. Aetna, which could be choppy as President Obama's health-care law is considered by the Supreme Court, is a Focus List Buy and a Long-Term Buy.


Shares of AGCO ($47; AGCO), a maker of agricultural equipment, have rallied 36% since the end of September yet trade at just 11 times trailing earnings, a 43% discount to their five-year average and 22% below their peer-group median. The Quadrix Value rank, currently 95, has exceeded 80 for nine straight month-ends. More than half of AGCO's individual Value factors score above 80.

AGCO expects production of tractors and combines to rise 5% in 2012, with total revenue growth exceeding 14%, helped by higher prices and market-share gains. The consensus calls for sales growth of less than 13%, leaving room for upside. Higher capital spending will likely cut into free cash flow, projected to exceed $200 million this year versus $426 million in 2011. Scoring the maximum 100 for both of our sector-specific ranks, AGCO is a Focus List Buy.


DirecTV's ($48; DTV) Value score, steadily climbing since September, now stands at 86, even as the company maintains its impressive operating momentum. DirecTV has posted eight straight quarters of double-digit sales growth and at least 25% growth in earnings per share. We expect DirecTV to continue delivering excellent growth the next two years as it tries to expand in Latin America.

For 2012, the consensus estimate projects per-share profits of $4.34, up 25%. Shares trade at just 11 times the 2012 estimate, a 28% discount to the median for cable and satellite stocks. If the stock's trailing P/E just holds at 14 — 26% below its three-year average — and DirecTV meets consensus profit estimates, shares will rally 25% by early next year. DirecTV is a Focus List Buy and a Long-Term Buy.

BONA FIDE VALUES
Below are 19 A-rated value plays that earn Quadrix Overall and Value scores of at least 80 and above-average scores in at least five of the eight most effective Value factors. For example, Aetna's price/cash flow ratio is lower than about 78% of U.S.-traded stocks. Very few stocks look cheap from all directions, and each of the 19 names seems attractively valued. Stocks recommended for purchase are listed in bold.
--------------------------- Quadrix Scores For Effective Value Factors ---------------------------
Quadrix Scores
Company (Price; Ticker)
Price/
Sales To
5-Year
Median
Enterprise
Value
EBITDA
Price/
Book
Price/Free
Cash Flow
Price/
Sales
Price/
Sales To
3-Year
Median
Price/
Earnings
Price/
Cash Flow
Value
Overall
Aetna ($47; AET)
40
87
52
84
83
22
89
78
89
96
Aflac ($47; AFL)
78
NA
54
98
64
73
79
NA
98
92
AGCO ($47; AGCO)
60
66
54
76
81
46
79
80
95
98
Apache ($101; APA)
81
91
58
60
33
84
89
90
95
99
Applied Materials
($13; AMAT)
85
66
46
78
46
80
77
63
89
90
Barrick Gold ($44; ABX)
85
72
47
NA
24
85
87
73
82
97
Best Buy ($27; BBY)
91
95
50
94
96
89
90
89
99
90
Chevron ($107; CVX)
54
91
50
39
66
59
90
85
88
94
Cisco Systems
($21; CSCO)
82
70
39
72
31
73
63
45
83
97
ConocoPhillips
($77; COP)
76
88
55
23
86
76
88
88
87
92
Dell ($17; DELL)
57
89
22
91
83
51
88
77
95
94
DirecTV Group
($48; DTV)
74
70
NA
55
56
74
65
77
86
95
Exxon Mobil ($87; XOM)
69
77
32
36
66
69
83
75
84
85
Halliburton ($33; HAL)
86
81
36
8
55
83
84
74
92
91
Intel ($28; INTC)
66
79
25
41
30
62
78
73
79
97
MetLife ($38; MET)
77
NA
91
95
80
74
95
NA
99
93
Occidental Petroleum
($98; OXY)
56
79
42
42
22
69
77
71
87
99
Teck Resources
($36; TCK)
84
90
69
83
41
86
91
82
97
93
Valero Energy
($28; VLO)
77
90
82
80
98
74
92
92
96
89
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not Available.

 


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com