Quadrix For The Long Haul

7/22/2013


Most of the back-tests we've done on our Quadrix rating system use 12-month holding periods, partly because we aim to limit our Buy List and Focus List to our top year-ahead picks. But we also use Quadrix scores for our Long-Term Buy List, and even our Buy List recommendations tend to stay on that list more than 12 months.

With that in mind, we decided to revisit how Quadrix scores have worked with longer holding periods, using stocks in the broad S&P 1500 Index since 1994. As shown below, top Overall scorers delivered higher annualized outperformance with 12-month rather than 36-month holding periods. For the full range of scorers, however, Overall scores did a better job of predicting forward returns using 36-month holding periods.


OVERALL QUADRIX SCORES — 33-BASKET ANALYSIS

For the top chart above, we divided stocks in the S&P 1500 Index into 33 baskets based on Overall Quadrix scores beginning in December 1994. Then we calculated forward 12-month returns relative to the return of the average S&P 1500 stock. Next, we repeated that process every month and calculated the average return for each of the 33 baskets.

For the bottom chart, we did the same thing, except using forward 36-month returns — and annualized those returns for comparability.


Interestingly, the worst Overall scorers delivered very poor relative returns based on 36-month holding periods, whereas the very worst scorers slightly outperformed with 12-month holding periods. That pattern did not hold for Quadrix Value scores, which also diminish in effectiveness more substantially as holding period is lengthened.

Based on the top one-fifth of S&P 1500 stocks, Value scores delivered slightly higher returns than Overall scores using 12-month holding periods, as shown below. But Overall worked considerably better than Value with 24- and 36-month holding periods, especially when volatility and winning percentage are considered.

QUADRIX SPOTLIGHT
Based on the annualized outperformance of the top one-fifth of stocks in the S&P 1500 Index since 1994, most Quadrix scores tend to deliver better results with shorter holding periods. But the standard deviation, or volatility, of outperformance tends to decline with the use of longer holding periods. As a result, the information ratio (outperformance divided by standard deviation), for Overall score is higher with longer holding periods. Winning percentage, or the percentage of holding periods in which the top one-fifth outperformed, is also higher with longer holding periods for the Overall score.
-------------- Holding Period --------------
12
Months
(%)
24
Months
(%)
36
Months
(%)
Overall
Annualized outperformance
2.4
2.3
2.1
Standard deviation
5.3
3.0
2.5
Information ratio
0.5
0.8
0.8
Winning %
64.9
75.9
78.6
Momentum
Annualized outperformance
0.4
(0.1)
0.1
Standard deviation
6.6
4.1
3.1
Information ratio
0.1
0.0
0.0
Winning %
56.9
51.8
52.4
Value
Annualized outperformance
2.5
1.8
1.4
Standard deviation
10.6
5.9
4.2
Information ratio
0.2
0.3
0.3
Winning %
56.9
56.8
58.8
Quality
Annualized outperformance
0.5
0.3
0.3
Standard deviation
6.7
4.6
3.6
Information ratio
0.1
0.1
0.1
Winning %
52.6
51.3
57.8
Financial Strength
Annualized outperformance
(0.6)
(0.1)
0.1
Standard deviation
6.9
4.4
3.2
Information ratio
(0.1)
0.0
0.0
Winning %
42.7
41.7
47.1
Earnings Estimates
Annualized outperformance
0.1
0.0
0.3
Standard deviation
7.4
3.9
2.7
Information ratio
0.0
0.0
0.1
Winning %
62.4
61.8
58.4
Performance
Annualized outperformance
(0.2)
(1.1)
(1.1)
Standard deviation
11.8
6.4
4.8
Information ratio
0.0
(0.2)
(0.2)
Winning %
53.1
55.8
48.1

While nothing ensures the next 19 years will be like the last 19, the data suggest long-term investors should pay extra attention to stocks with high Overall scores. Listed in the table below and reviewed below are Quadrix standouts, all of which hold both year-ahead and long-term appeal.

Aflac's ($59; AFL) core business is in Japan, which accounted for 80% of 2012 operating income. But U.S. operations could gain momentum with the pending health reform. While many U.S. employers will likely continue to offer comprehensive coverage, they may shift more of the costs to workers, resulting in higher copayments. That trend could steer more workers toward Aflac's specialty: supplemental insurance coverage that defrays out-of-pocket expenses.

While the Japanese yen continued to deflate in the June quarter, the average daily currency rate hovers within management's targeted range. Aflac said in April that it expects June-quarter earnings per share of $1.41 to $1.56, compared to the consensus of $1.51. Although the Overall score has slipped to 88, the stock ranks among the cheapest in our research universe with a Value score of 98. Aflac, yielding 2.4%, is a Buy and a Long-Term Buy.


Foot Locker's ($36; FL) same-store sales growth has exceeded 5% in 11 consecutive quarters, boosted by strong trends in athletic apparel and shoes. The July quarter appears to be shaping up fairly well. Industrywide, sales of basketball shoes rose 3% in May and 6% in June, according to researcher NPD. Sales of running shoes slipped 1% in June after climbing 3% in May. Foot Locker has an especially strong presence in basketball shoes. However, starting in July, year-over-year comparisons for basketball shoes will become more challenging.

The consensus expects earnings of $2.82 per share for fiscal 2014 ending January, up 10% on 3% sales growth. Foot Locker's forward P/E of 13 is 21% below the median for S&P 1500 apparel retailers. Shares trade at less than 15 times trailing earnings, a 35% discount to their five-year average. Foot Locker, yielding 2.2%, is a Focus List Buy and a Long-Term Buy.


Helmerich & Payne ($64; HP), an oil and natural-gas drilling contractor, grew sales 17% and operating cash flow 9% in the 12 months ended March. But sluggish natural-gas prices have tested North American drillers' desire to ramp activity. As a result, pockets of the onshore drilling market appear saturated, most recently evidenced by rival Nabors Industries ($15; NBR) warning June-quarter results would miss expectations.

With its fleet of high-end land rigs, H&P seems better positioned to weather the lull. Although H&P's per-share profits could dip slightly in the June and September quarters, analyst estimates have held up fairly well in the past two months.

The stock may already reflect a lot of the industry's risks, given that it scores above 70 in two-thirds of the individual factors for Value. Drilling down further, H&P scores above 80 for enterprise ratio and price/cash flow ratio — two of the most effective Quadrix Value variables over the past decade. Helmerich & Payne, yielding 3.1%, is a Focus List Buy and a Long-Term Buy.


In the June quarter, J.P. Morgan Chase ($55; JPM) earned $1.60 per share, up 32% and $0.16 above the consensus. Revenue advanced 13% to $25.96 billion, surpassing the consensus of $24.84 billion. Results benefited from a decision to draw down reserves for loan losses. Excluding the reserve draw-down, J.P. Morgan earned $1.45 per share. The investment bank and the asset-management unit both posted double-digit growth for revenue and net income. Average total deposits swelled to nearly $454 billion, up 10% year-over-year.

Mortgage originations grew 12% from the year-earlier period, though they declined 7% from March-quarter levels. Refinancing activity has slowed in July as interest rates surged. Net interest margin continued to contract, the result of lower loan yields and a higher cash balance; management expects net interest margin to stay fairly stable in the second half of 2013. J.P. Morgan Chase, with an Overall score of 99 and a dividend yield of 2.8%, is a Focus List Buy and a Long-Term Buy.


Magna International ($73; MGA) earns a Value rank of 75, lower than most of the stocks listed above. But four of its five other category scores exceed 80, contributing to an Overall rank of 97. Also, Magna scores well in three Value factors especially effective at predicting 12-month outperformance: price/sales ratio (84), price/cash flow ratio (80), and enterprise ratio (74).

Magna manufactures automotive systems and components for most of the world's largest carmakers. Buoyed by resurgence in the U.S. automobile market, Magna posted growth of 8% for revenue, 11% for operating profits, and 37% for cash provided by operations in the 12 months ended March.

Magna seems capable of building on that momentum. In June, General Motors ($36; GM) posted its best month of U.S. vehicle sales since September 2008, while Ford Motor ($17; F) reported 13% growth and Toyota Motor ($129; TM) 14%. For the June quarter, the consensus expects Magna to report 8% higher earnings per share on 9% sales growth. Magna, yielding 1.8%, is a Focus List Buy and a Long-Term Buy.

16 QUADRIX STANDOUTS

We screened for recommended stocks scoring above 87 for Overall and above 70 for Value. Many of the 16 selected stocks also score above 80 for at least one of the three most effective individual Quadrix variables over the past decade: price/sales, price/cash flow, and enterprise value/EBITDA.

A consistently high Overall score is a bullish indicator, and nine of the 16 have scored above 80 on at least 20 of the last 24 month-ends. Another useful indicator we consider is the percentage of individual Quadrix variables with very high scores, with CF Industries ($181; CF) a standout on this measure.

-- Quadrix Scores --
--- Price/Sales ---
Enterprise Value/
----- EBITDA -----
Price/Cash Flow
Months
Overall
Above
80 In
Past 24
% Of
Factors
Above 90
Company (Price; Ticker)
Overall
Value
Ratio
Score
Ratio
Score
Ratio
Score
Aflac ($59; AFL)
88
98
1.1
67
NA
NA
NA
NA
24
7
Bed Bath & Beyond
($76; BBBY)
92
76
1.5
56
8.4
61
13.3
45
24
10
CF Industries ($181; CF)
97
98
1.9
47
3.3
95
4.7
91
24
27
Cisco Systems ($26; CSCO)
93
78
2.8
32
7.8
66
11.1
58
20
0
Cognizant Technology
($71; CTSH)
96
71
2.8
33
11.8
35
16.9
30
18
15
DirecTV ($65; DTV)
98
92
1.2
65
6.8
74
6.4
84
24
11
Express Scripts ($65; ESRX)
93
82
0.5
86
10.4
45
13.6
43
12
19
Foot Locker ($36; FL)
97
87
0.9
73
6.1
80
10.5
62
24
8
Helmerich & Payne
($64; HP)
99
88
2.1
43
5.2
87
6.6
83
24
2
J.P. Morgan Chase
($55; JPM)
99
91
1.9
46
5.2
87
7.5
79
14
8
Kroger ($38; KR)
97
81
0.2
97
6.0
81
6.0
86
13
4
Macy's ($50; M)
95
83
0.7
80
6.6
76
7.9
77
21
1
Magna International
($73; MGA)
97
75
0.5
84
6.9
74
7.3
80
18
6
Mylan Laboratories
($32; MYL)
95
80
1.7
50
9.9
49
10.6
61
13
2
Qualcomm ($62; QCOM)
96
78
4.8
17
12.0
35
14.5
39
18
13
Wells Fargo ($43; WFC)
96
85
2.5
37
5.8
82
9.8
66
21
6

 


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