Quality Out Of Favor, Not Out Of Mind

12/31/2012


Shrewd collectors tend to buy the best they can afford.

Pay up for the vintage Ansel Adams print, don't compromise on the condition of a first-edition Spiderman comic, and keep pursuing that rare strand of Abe Lincoln's hair, provided it comes with the proper provenance.

The marketplace for such treasures may be fickle in stretches. But over time, a thirst for the rare and the exceptional can push up prices of high-quality pieces while the common lose value.

Collectors of equities often put a similar emphasis on high-quality stocks: companies that have cultivated a track record of long-term growth, run by executives capable of delivering consistent results. Pedigree often commands a premium. But is it warranted for stocks?

Our Quadrix Quality score considers more than 20 factors that measure, among other things: growth trends for sales, earnings, cash flow, and dividends over different time periods; returns on assets, equity, and investment; and expected long-term profit growth. In short, the Quality score rewards companies that effectively use their capital and grow. More details on the Quality score and the other Quadrix category scores are available at www.DowTheory.com/Go/Quadrix.

QUALITY SHINES FOR TECH

Focusing on stocks with high Quality scores has given investors an edge since 1994 and over the past five years. But that strategy hasn't worked in the past 12 months for any sector except technology. Below, we compare rolling 12-month total returns for S&P 1500 Index stocks with Quality scores above 80 relative to the median stock in each sector. For instance, the median technology stock with a Quality score above 80 outperformed the median stock in the sector by 4.1% over the last 12 months, while the median high-scoring materials stock underperformed by 7.7%.

Winning percentage is the percentage of periods since 1994 in which top Quality scorers topped the median return. We did not present data for the telecom-services and utilities sectors because of the lack of historical data; in some periods, no stocks in the sectors earned a Quality score above 80.

----- Average 12-Month Performance -----
Total Return,
-- Last 12 Months --
Last 60
-- Rolling Periods --
---- Since 1994 ----
S&P 1500 Sector
Median
Top
Quality
Scorer
(%)
Sector
Median
(%)
Median
Top
Quality
Scorer
(%)
Sector
Median
(%)
Median
Top
Quality
Scorer
(%)
Sector
Median
(%)

Winning
% Since
1994

Cons. Discretionary
12.7
20.7
8.5
4.5
9.5
6.6
75
Consumer Staples
12.6
17.9
7.8
8.0
10.0
11.0
40
Energy
(8.4)
(8.2)
7.2
7.6
20.5
15.5
52
Financials
19.4
21.0
(3.0)
(0.5)
11.9
11.4
49
Health Care
13.8
16.0
4.3
4.3
9.9
9.6
49
Industrials
10.4
13.2
5.5
4.3
8.2
9.0
44
Materials
4.9
12.6
8.6
5.7
9.2
7.0
65
Technology
6.3
2.2
4.6
2.8
7.3
6.2
63
S&P 1500
9.7
13.2
4.6
3.4
8.4
8.1
50

Concentrating on stocks with high Quality scores sounds like an attractive strategy. It steers investors toward success stories. And the Quality rank is skewed toward long-term trends, making it less volatile than other Quadrix scores. Investors who build a portfolio around high Quality scorers shouldn't see much turnover.

To measure the Quality score's effectiveness, we analyzed rolling 12-month returns for S&P 1500 stocks with Quality ranks above 80. The median top Quality scorer has outperformed the median stock in the index by an average of 0.4% in rolling periods since 1994 and 1.2% over the past five years. But over the last year, the median Quality leader underperformed by an average of 3.5%.

Growth of a company's business doesn't always translate into higher returns for investors. The price paid for those companies also plays an important role. Yet the median S&P 1500 stock that scored above 80 for both Value and Quality 12 months ago underperformed the median stock by 10.7%. Over longer periods, however, the Quality and Value strategy has paid off. In rolling periods since 1994, stocks with high scores in both Quality and Value have outperformed the median stock by an average of 3.9%.

Over the last year, Quality has underperformed the median stock in most S&P sectors. Quality has worked in the technology sector, where the median stock scoring above 80 outperformed the sector median by 4.1%.

Some of the Forecasts' favorite technology plays are shown below. Most have performed quite well over the last year. Do they still have the room to run higher? In most cases, they appear attractively valued — though as mentioned earlier, that's no guarantee of future outperformance.

SCREEN OF THE MONTH: TECH COMES OUT ON TOP
Below we present our recommended technology stocks that earn Quality scores above 80 today and also earned such scores a year ago. Only Intel ($21; INTC) has delivered a total return below 7% in the past year. All of the stocks except Visa ($151; V) seem reasonably valued, and Visa's exceptional and steady growth warrants a premium price.
12-Mo.
Total
Return
(%)
Quadrix Quality
------ Score ------
Current Quadrix
------ Score ------
Company (Price; Ticker)
Dec. 30,
2011
Current
Value
Overall
Industry
Alliance Data Sys.
($147; ADS)
39
93
95
49
76
IT Services
Apple ($520; AAPL)
30
100
100
88
91
Computers
EMC ($26; EMC)
17
87
89
68
78
Computers
Google ($710; GOOG)
12
98
97
41
75
Internet Software
Intel ($21; INTC)
(12)
92
93
89
69
Semiconductors
Microsoft ($27; MSFT)
7
94
86
84
70
Software
Oracle ($34; ORCL)
31
96
94
70
86
Software
Qualcomm
($62; QCOM)
15
90
91
50
90
Telecom Equip.
Visa ($151; V)
49
95
94
26
84
IT Services
Avg. for stocks above
21
94
93
63
80
Avg. for S&P 1500
tech stocks
12
67
62
51
53
Note: Quadrix scores are percentile ranks, with 100 the best.

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