Modest Risk, High Potential
An increasingly frothy market has investors searching for stocks with three highly desirable traits: a reasonable valuation offering plenty of room for upside; limited share-price volatility should the market retreat from recent all-time highs; and the ability to grow earnings in a slow economy.
We screened for high-potential value stocks with a defensive slant, insisting on the following:
• Relative Risk ratings of below-average or low. Our risk ratings slot stocks into five categories based on five measures of share-price volatility over the past 60 months, including worst three-month performance, bull- and bear-market performance, standard deviation, and beta.
• Broad-based strength in Quadrix. We required Overall scores of at least 89 along with Value, Quality, and earnings-predictability scores above 60. A gauge of the consistency of year-to-year earnings growth over the last five years, earnings predictability helps uncover persistent growers.
• Solid earnings momentum, with higher per-share earnings expected this year and in 2014. We also looked for companies that met or surpassed consensus profit estimates in the last four quarters, offering confidence they can at least meet near-term earnings expectations.
• Reasonable valuations, with estimated current-year and next-year price/earnings ratios at sizable discounts to sector averages.
Express Scripts ($67; ESRX), a stock with a low Relative Risk rating, earns an impressive earnings-predictability score of 95. The Overall score stands at 93, with scores above 80 in Momentum and Value. The pharmacy-benefit manager is benefiting from increased usage of higher-margin generic drugs. In addition, healthy member enrollment and high client- retention rates bode well for growth.
June-quarter results should be announced on July 29. Per-share earnings are expected to be $1.10, up 25%. For 2013, per-share profits are expected to increase 15% to $4.30 on 8% sales growth. Share buybacks, fueled partly by the company's rich cash flow, should help sustain earnings growth. Express Scripts repurchased 5 million shares in the March quarter, leaving about 70 million shares remaining in the current program. Express Scripts is a Focus List Buy and a Long-Term Buy.
Kroger ($39; KR) earns a Quadrix Overall score of 98, versus an average of 62 for the 21 food retailers in our research universe. The earnings-predictability score is a solid 86, partly reflecting an enviable record of revenue growth — same-store sales have increased for 38 straight quarters. Kroger targets long-term annual profit growth of 8% to 11%. To fund growth and make acquisitions, Kroger will draw on its robust cash flow, which jumped 27% to $6.00 per share in the 12 months ended April.
Even with a 51% rally this year, shares remain reasonably valued considering their growth outlook. Shares trade at 14 times estimated current-year earnings, a 29% discount to the average consumer-staples stocks in the S&P 1500 Index. Kroger, a stock with a low Relative Risk rating, is a Focus List Buy and a Long-Term Buy.