Finding Strength In Sectors

7/23/2012


With the stock market's momentum sagging as we slog through the summer, we've turned to our sector-specific scores for ideas that could spark returns over the next 12 months.

Investors should consider stocks with sector scores above 80, a proven strategy for picking winners. Our traditional Quadrix scores compare nearly 4,500 stocks to each other. But because not all sectors behave the same, we designed two additional ranks tailored to the idiosyncrasies of each group. The 12-Factor Sector score uses a dozen statistics that are highly effective at predicting outperformance in a particular sector. The Reranked Overall score reweights the same six categories that comprise the Overall score according to their effectiveness in specific sectors. In all 10 S&P 1500 sectors, top-ranked stocks have outperformed the average stock in rolling 12-month periods since 1994.

Investors can also focus on the traditional Quadrix category scores that identify winners in each sector. To find which scores worked best, we measured the performance of stocks that ranked in the top quintile (top one-fifth) in the various categories.

In the tables below, we show the two most effective categories for eight of the 10 market sectors during the past 12 months, over the last five years, and since 1994. We excluded telecom and utilities because our buy lists contain no stocks from these sectors. We also list two or three A-rated stocks, most of which score well in crucial categories and earn favorable sector-specific ranks.

Four favorites are reviewed below.

Agilent Technologies ($37; A) scores an 85 for Value, the best Quadrix category for predicting outperformance among S&P 1500 health stocks over the past five years and since 1994. Both sector-specific ranks exceed 80. Agilent officially resides in the health-care sector, though it is a health/technology hybrid. It makes testing equipment used by smartphone and semiconductor makers, drug companies, and laboratories. Agilent is also partnering with the U.S. Food and Drug Administration to build a DNA database for food-borne germs.

The June acquisition of a Danish company that makes cancer diagnostics for $2.2 billion should boost sales by $115 million in fiscal 2012 ending October and by $370 million in fiscal 2013. That's a small bump for Agilent, which produced $6.63 billion in revenue during fiscal 2011. But the deal further diversifies Agilent's revenue stream. At the end of April, Agilent held $3.90 billion in cash — mostly in overseas accounts — versus long-term debt of $1.93 billion. Per-share profits are projected to rise 9% in the July quarter and climb 14% annually over the next five years. With shares trading at 12 times trailing earnings, 46% below the five-year average, Agilent is a Focus List Buy and a Long-Term Buy.

HEALTH CARE
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
2.3
Momentum
0.3
Past 5 years
Value
0.7
Quality
0.1
Past 12 months
Momentum
7.1
Performance
6.9
Top A-rated stocks
Company (Price; Ticker)
Momen-
tum
Value
12-Factor
Sector
Reranked
Overall
Agilent Technologies ($37; A)
61
85
88
98
McKesson ($96; MCK)
72
67
98
95
Merck ($44; MRK)
84
60
46
88

S&P 1500 materials stocks have consistently outperformed their peers when scoring above 80 for Value or Quality. CF Industries ($204; CF) has scored in the top quintile for both Value and Quality every month since September. During that period, CF shares, admittedly linked to the volatility of commodity prices, have rallied 65%.

CF also earns maximum scores of 100 for both sector-specific ranks. Five of six Quadrix category scores exceed 80, while the Earnings Estimates rank has risen to 76 as analysts ratcheted up profit projections ahead of the June-quarter report. The consensus profit estimate for the quarter has risen 5% in the past month to $8.85 per share, implying 29% growth.

Driving profit growth are high prices for fertilizer and the persistent weakness of natural gas, a critical raw material for CF's products. Earlier this month, with fields wilting under the heat wave rolling through the Midwest, the U.S. Department of Agriculture lowered its corn-yield forecast by 12%. With U.S. supplies dwindling, corn prices have risen, compelling many farmers to maximize the yields of a smaller crop by applying more fertilizer. CF Industries is a Focus List Buy and a Long-Term Buy.

MATERIALS
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
6.9
Quality
2.7
Past 5 years
Value
10.7
Quality
4.6
Past 12 months
Quality
3.3
Value
3.3
Top A-rated stocks
Company (Price; Ticker)
Value
Quality
12-Factor
Sector
Reranked
Overall
Barrick Gold ($35; ABX)
87
91
32
98
CF Industries ($204; CF)
90
100
100
100
Teck Cominco ($30; TCK)
98
81
24
96

The steady nature of Oracle's ($30; ORCL) maintenance contracts provides shelter from the vacillations of enterprise clients, many loathe to ramp spending while Europe lies in tatters. Oracle has captured share from rival SAP ($61; SAP) in the applications market in recent years, and now it looks to challenge Salesforce.com ($127; CRM) in cloud computing. Free cash flow, rising in nine straight quarters, has fattened Oracle's balance sheet; net of debt, Oracle holds $14.20 billion in cash, nearly four times higher than two years ago. And Oracle has widened operating profit margins, with quarterly margins now within one percentage point of levels prior to the Sun Microsystems merger.

Oracle scores above 80 for Quality — the top category for predicting outperformance in technology stocks since 1994 — and Financial Strength, the best over both the past 12 months and five years. Moreover, it scores a 97 in Earnings Estimates, also an effective category in the past year.

Shares have rallied 17% this year, ahead of the average return of 1% for S&P 1500 tech stocks. Yet Oracle trades at just 12 times trailing earnings, 19% below its sector median and 36% below its five-year average. With both sector-specific ranks above 90, Oracle is a Long-Term Buy.

TECHNOLOGY
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Quality
3.2
Value
1.6
Past 5 years
Fin'l Strength
1.5
Quality
1.0
Past 12 months
Fin'l Strength
2.8
Earnings Ests.
1.6
Top A-rated stocks
Company (Price; Ticker)
Quality
Fin'l
Str.
12-Factor
Sector
Reranked
Overall
Apple ($607; AAPL)
100
99
100
100
KLA-Tencor ($46; KLAC)
90
86
72
86
Oracle ($30; ORCL)
96
82
94
97

For nearly a decade, shares of Wal-Mart Stores ($73; WMT) were range-bound. They never slipped below $42 or rose above $64; they mostly seemed to lounge in the range from the high-$40s to mid-$50s. But the shares woke from their slumber this year, surging 22% to an all-time high in July. By comparison, the S&P 1500 Consumer Staples Sector Index has advanced 8% so far in 2012.

Among the retailers at the forefront of melding their physical stores with their Web presence, Wal-Mart accommodates a segment of the population that prefers the convenience of shopping online without worrying about the security of their financial information. More than half of Walmart.com orders are picked up at stores, and many of those customers pay at the store rather than online.

Profit estimates for both the July quarter and fiscal 2013 ending January have drifted higher in the past 60 days. Although Wal-Mart no longer gives monthly sales updates, June same-store sales for U.S. retailers showed strength at both high-end retailers and discounters, while growth sagged at stores catering to the middle class. Wal-Mart Stores is a Long-Term Buy.

CONSUMER STAPLES
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
2.6
Momentum
1.2
Past 5 years
Quality
2.4
Earnings Ests.
0.2
Past 12 months
Quality
9.4
Fin'l Strength
6.1
Top A-rated stocks
Company (Price; Ticker)
Quality
Earns.
Ests.
12-Factor
Sector
Reranked
Overall
CVS Caremark ($48; CVS)
75
88
88
92
Wal-Mart Stores ($73; WMT)
78
89
70
87

CONSUMER DISCRETIONARY
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Momentum
2.5
Value
2.5
Past 5 years
Value
3.1
Quality
2.0
Past 12 months
Momentum
8.2
Earnings Est.
7.9
Top A-rated stocks
Company (Price; Ticker)
Momen-
tum
Value
12-Factor
Sector
Reranked
Overall
DirecTV ($49; DTV)
72
85
63
75
Volkswagen ($32; VLKAY)
81
98
48
100
Wyndham ($51; WYN)
90
37
86
89

 

ENERGY
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
2.2
Quality
0.5
Past 5 years
Earnings Ests.
1.1
Fin'l Strength
(1.4)
Past 12 months
Earnings Ests.
6.4
Quality
(0.9)
Top A-rated stocks
Company (Price; Ticker)
Value
Earns.
Ests.
12-Factor
Sector
Reranked
Overall
Apache ($86; APA)
96
3
85
83
Chevron ($107; CVX)
84
16
83
79
Valero Energy ($25; VLO)
97
97
74
74

 

FINANCIALS
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
4.7
Quality
1.3
Past 5 years
Value
4.2
Quality
0.5
Past 12 months
Quality
5.0
Performance
3.9
Top A-rated stocks
Company (Price; Ticker)
Value
Quality
12-Factor
Sector
Reranked
Overall
Aflac ($44; AFL)
98
81
93
100
BlackRock ($176; BLK)
68
86
86
71
J.P. Morgan Chase ($35; JPM)
95
46
56
74

 

INDUSTRIALS
Time Period
Top
Category
Excess
12-Mo.
Return
(%)
Runner-Up
Excess
12-Mo.
Return
(%)
Since 1994
Value
2.3
Performance
(1.3)
Past 5 years
Value
0.7
Quality
(1.1)
Past 12 months
Quality
3.3
Fin'l Strength
2.4
Top A-rated stocks
Company (Price; Ticker)
Value
Quality
12-Factor
Sector
Reranked
Overall
AGCO ($42; AGCO)
95
91
100
91
CSX ($23; CSX)
71
88
50
93
Southwest Airlines ($9; LUV)
89
51
97
100

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