When Is A Laggard Not A Loser?
Investors like a good comeback story. That desire probably accounts for much of their fascination with stocks on the rocks.
But not all stock-price declines are created equal. In our eyes, Aflac ($40; AFL), trading 20% below its 52-week high, looks like a rebound play. But Vornado Realty Trust ($80; VNO), down a similar percentage, looks more like a stinker. How do you separate the wheat from the chaff? Understand these three trends, and you'll increase your chances of success.
• Stocks closest to their 52-week highs tend to outperform. Check out the chart below. In rolling periods since 1994, S&P 1500 Index stocks trading within 5% of their 52-week highs averaged 12-month returns of 11.6%. That average return declined for each of the next 5% intervals, as did the percentage of stocks that earned positive returns. While deep values at least 40% below their 52-week highs averaged solid 10.0% returns, such stocks were exceptionally volatile.
Takeaway: Investors generally do better picking stocks that have not fallen far from their highs.
• Stocks that have lagged the market have tended to outperform in recent years. Since 1994, S&P 1500 Index stocks have averaged 12-month returns of 12.6%. Stocks that underperformed the index average by more than 5% in the prior 12 months averaged 13.7% returns. For stocks that lagged by a larger amount, the average return increased.
Takeaway: Don't be afraid to buy stocks that have lagged the market.
• The strong stand out from the pack. In our Quadrix universe of more than 4,400 companies, stocks that outperformed the S&P 1500 Index over the last year average Overall scores of 57, versus 43 for underperformers. Outperformers average higher scores in every category except Value. The S&P 1500 Index of large, medium-size, and small stocks exhibits similar trends. We looked at numbers over the last 15 years, and the relationship between the scores of outperformers and underperformers has not changed over time.
Takeaway: Most stocks lag the market for a good reason, and weak fundamentals suggest you can't count on them to catch up in the future.
Don't be fooled. While on the surface these trends seem to contradict each other, they make sense when you consider that the first two studies looked only at returns. Investors can dig deeper to find stocks that share key characteristics. For instance, the table below lists seven A-rated stocks that have lagged the index by at least 5% over the last year but still trade within 20% of their 52-week highs. We also present a few well-known stinkers that meet the same criteria, though we wouldn't buy them. Three particularly appealing stocks are reviewed in the following paragraphs:
Concerns about Europe's debt crisis still drag on Aflac ($40; AFL), which has fallen 11% over the last year and 13% over the last three months. The stock trades at roughly six times trailing earnings, 9% below its peer group and less than half of its own five-year average P/E ratio. Death's-door valuation aside, the insurer looks pretty healthy. Sales and profit growth have accelerated in each of the last three quarters, while operating cash flow jumped 55% over the last year.
While Europe's woes are no joke, Aflac's exposure has declined drastically in recent years, and the shares have been punished too harshly. The insurer has divested $580 million in bonds since the end of March and says its de-risking efforts are pretty much over. Sovereign and bank bonds from countries on the periphery of the euro zone account for only 2% of Aflac's investment portfolio. Aflac, with an Overall rank of 97, Value rank of 98, and at least 90 in both of our sector-specific scores, is a Buy and a Long-Term Buy.
DirecTV's ($46; DTV) Quadrix Performance score of 55 reflects choppy stock action in recent months, hurt by concerns about weakening consumer spending and an economic slowdown. But you can't blame price weakness on DirecTV's operating results; in each of the last five quarters, the company managed at least 11% sales growth and 25% higher per-share profits. Analysts expect the growth to continue, projecting per-share profit growth of 26% this year and 21% in 2013.
Latin American operations should drive much of the company's growth. DirecTV is investing heavily in key South American markets, with plans to bid on Brazilian wireless spectrum valued at nearly $2 billion. In the U.S., DirecTV hopes to protect or improve profitability by holding the line on higher programming costs — threatening to black out shows rather than pay more — and developing more of its own content.
DirecTV shares look cheap from just about every angle. The stock trades at least 20% below its five-year average trailing price/earnings, price/sales, and price/cash flow ratios. And at less than 11 times the 2012 profit consensus, DirecTV sells at a 26% discount to the median pay-TV company in the S&P 1500. DirecTV is a Focus List Buy and a Long-Term Buy.
Over the last 12 months, shares of Express Scripts ($52; ESRX) have slumped 2%, lagging the S&P 1500 Index's return by 5%. During that same period, the pharmacy-benefit manager's per-share profits rose 13% and its operating cash flow jumped 55%. The company has repurchased enough shares to lower the share count by 12% over the last two years. Cost savings from the April 2 merger with Medco Health Solutions should help sustain earnings growth.
At 15 times projected 2012 earnings, Express Scripts trades roughly in line with the average health-care services provider. The stock has historically commanded a premium to the group. The shares trade 24% below their three-year average trailing P/E ratio, with discounts of 26% on price/sales and 17% on price/cash flow. With Wall Street expecting profit growth of 19% this year and 24% next year, Express Scripts is a Buy and a Long-Term Buy.