Using Our Buy Lists

8/5/2013


While trying to be all things to all people is not the way to survive in the investment-newsletter business for 68 years, our buy lists serve a variety of investors.

For those of a love-it-or-leave-it persuasion, we recommend our Focus List, limited to our favorite 12 to 18 picks for year-ahead returns. Our Buy List, with 25 to 30 names, is also limited to top 12-month picks. But the Buy List is a fairly diversified portfolio, while the Focus List is more appropriate as part of a broader portfolio. Our Long-Term Buy List, with 30 to 40 stocks, is for those who prefer to take a longer view, limiting turnover by focusing on 24- to 48-month returns.

As shown below, all three lists have delivered strong returns relative to the broad market since 2000, the year we introduced our Quadrix stock-rating system. For all three lists, average holding periods have been considerably longer than 12 months. For stocks dropped from the Focus List since year-end 2003, the average period on the list was 16 months. That compares to 22 months for the Buy List and 36 months for the Long-Term Buy List.


OUR LISTS OUTPERFORM

----------- Price Change -----------
Focus
List
(%)
Buy
List
(%)
L-T
Buy
List
(%)
S&P
500
Index
(%)
2000
14.0
(1.4)
5.0
(10.1)
2001
(16.0)
(15.6)
0.3
(13.0)
2002
(28.9)
(25.8)
(18.2)
(23.4)
2003
20.2
29.2
24.6
26.4
2004
17.5
22.4
9.0
9.0
2005
8.1
13.2
4.1
3.0
2006
12.9
16.9
9.7
13.6
2007
22.8
19.2
10.8
3.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2009
40.0
37.6
30.6
23.5
2010
19.5
12.7
10.3
12.8
2011
(4.8)
(9.1)
(4.2)
0.0
2012
14.2
16.0
15.8
13.4
2013 *
20.7
24.3
23.9
18.2
Since 2000 *
62.0
68.1
86.1
14.7
Since 2003 *
138.0
172.4
116.2
91.6
 

* Through July 30.

Returns assume fully invested portfolios and exclude dividends and transaction costs.

 

We don't view an average holding period exceeding 12 months as inconsistent with the objectives of our Focus and Buy lists, as a stock can remain a year-ahead favorite far longer than a year. Still, with the benefit of hindsight, we have probably been too slow to drop names from the Focus List. With such a concentrated portfolio, a single laggard can seriously retard returns. Even a sideways-moving laggard can be a big drag in a bull market, as it will take a slot that could have gone to a winner. Look for us to be quicker to make Focus List rank changes — especially when Overall Quadrix scores drop below 80, like we are doing this week.

Our work with Quadrix suggests investors seeking 12-month returns should react quickly to deteriorating fundamentals. As shown in the back-test description on the right, a strategy of selling any stock that sees its Overall Quadrix score drop below 80 added meaningfully to returns. After factoring in trading commissions, even portfolios as small as $50,000 were better off using 80 as a sell threshold than 60.

Picking a list

If you want only our best ideas and are using our advice to manage a portion of your portfolio, mimic our Focus List. If you manage the bulk of your money with our picks, mimic the Buy List or Long-Term Buy List. Not surprisingly, the Buy and Long-Term Buy lists include many of the same stocks. But, especially compared to the Focus List, the Long-Term Buy List is more likely to stick with a quality blue chip if its valuation goes from cheap to middling. For example, on our July 24 hotline, American Express ($75; AXP) was dropped from the Buy List but retained as a Long-Term Buy. If you are mimicking the Buy List, you should have sold American Express on July 25.

Another example: On Nov. 8 Express Scripts ($65; ESRX) was dropped from the Focus List but retained as a Buy and a Long-Term Buy. The stock jumped nearly 11% from Nov. 8 to May 16, when it returned to the Focus List.

Was dropping Express Scripts from the Focus List for that nearly six-month period a good move? For our money, the answer is clearly yes, as the Focus List gained nearly 19% over that period. But if your answer is no because of the trading costs, taxes, and hassle of trading, the Buy List or Long-Term Buy List are probably more appropriate for you than the Focus List.

Some other points to consider as you look at our buy lists:

• According to the independent Hulbert Financial Digest, the Focus List was 8% less volatile than the broad Wilshire 5000 Index from its 1995 inception through June 30, while the Buy List was 18% less volatile. The Long-Term Buy List, followed by Hulbert since 2002, was 25% less volatile. These numbers, based on the variation of monthly returns, reflect both our stocks and our position in a short-term bond fund.

• According to Hulbert, both our Focus List and Buy List outperformed the S&P 500 Index for the 10 and 15 years ended June 30. Because they had lower volatility than the index, they outperformed by a bigger margin on a risk-adjusted basis. The Long-Term Buy List matched the S&P 500 for the 10 years but outperformed on a risk-adjusted basis. Overall, Hulbert says Dow Theory Forecasts delivered a 6.1% annualized return for the 15-year period, versus 4.3% for the S&P 500. Over 15 years, a $200,000 portfolio turns into $486,319 at a 6.1% annual rate, versus $376,092 at a 4.3% annual rate.

• Assuming commissions of $10 per trade, estimated trading costs for the Focus List averaged about $224 per year from 2004 through 2012, versus $351 for the Buy List and $298 for the Long-Term Buy List. For a $100,000 portfolio, those costs equate to an average annual drag of 0.22% for the Focus List, 0.35% for the Buy List, and 0.30% for the Long-Term Buy List. Of course, our numbers don't reflect taxes or the potential market impact of making a trade.

BUY LIST STATS
Current Recommendations *
Stocks Up
On List
Stocks Down
On List
Avg Chg.
On List
(%)
Avg.
Months
Held
Focus List
12
2
37.3
11.6
Buy List
27
0
37.7
17.1
L-T Buy List
35
1
40.5
23.0
* Excluding this week's additions.
Closed-out recommendations
Stocks
Sold With
Gains
Stocks
Sold With
Loss
Avg. Chg.
Of Stocks
Sold
(%)
Avg.
Months
Held
Focus List
2013
6
3
18.8
8.5
2012
8
6
6.3
8.2
2011
11
7
1.8
10.0
2010
10
6
25.2
13.6
2009
1
7
(24.1)
16.9
2008
5
8
5.7
24.6
2007
6
2
56.4
28.5
2006
5
5
29.9
19.8
2005
4
3
8.2
21.6
2004
6
1
18.9
17.9
Buy List
2013
5
1
17.5
11.9
2012
14
7
11.3
14.3
2011
14
10
4.0
11.7
2010
11
10
21.2
21.6
2009
4
10
(15.4)
35.9
2008
9
10
3.3
23.4
2007
15
6
29.0
24.8
2006
8
4
40.7
33.7
2005
11
4
41.7
26.0
2004
7
4
22.7
22.2
Long-Term Buy List
2013
6
3
8.9
41.4
2012
10
8
13.5
22.8
2011
12
7
17.1
16.7
2010
9
10
32.7
41.5
2009
5
6
7.3
47.3
2008
7
11
0.9
46.4
2007
10
6
37.2
41.2
2006
7
4
55.4
44.5
2005
4
6
17.2
36.4
2004
3
9
(11.8)
30.4


Rank changes

We are making several changes to the Focus List this week, adding Lear ($69; LEA) and Cognizant Technology ($72; CTSH) while dropping B/E Aerospace ($69; BEAV), BlackRock ($282; BLK), and Google ($891; GOOG). Lear, reviewed in Analysts' Choice, is replacing BlackRock on the Buy List.

Cognizant has rallied 13% since July 1 but seems reasonably valued at 17 times expected current-year earnings — in line with the technology-consulting group and at a discount to the broader tech sector. Based on price/earnings, price/sales, and price/cash flow ratios, the stock trades at a considerable discount to historical norms. June-quarter results, due in early August, should show growth of 20% to 25% in per-share share earnings and 17% to 20% in sales. Double-digit profit growth seems likely through 2014, though an immigration overhaul could hinder results if it becomes harder to outsource work to India. Cognizant, already a Buy and a Long-Term Buy, is joining the Focus List.


B/E Aerospace delivered solid June-quarter results, with both sales and earnings exceeding consensus expectations. But the stock has moved sideways since the report, and its Overall Quadrix score has dropped to 75 because of drops in the Momentum and Value scores. While B/E remains a Buy and a Long-Term Buy based on its superior profit-growth prospects, it no longer ranks among our very favorites.


BlackRock has rallied 4% since its June-quarter report, moving within striking distance of its May all-time high near $298. While a near-term breakout above that level would not be surprising if the stock market pushes higher, shares of the asset-management company are also likely to be highly sensitive to a market pullback. With the stock up more than 18% since its Feb. 28 addition to the Focus List, BlackRock's risk-reward tradeoff is no longer particularly compelling for the year ahead. BlackRock remains a Long-Term Buy.


Google remains among our favorite picks in the tech sector. The company seems well-managed, though not particularly shareholder-friendly, and its advertising-driven business model allows it to disrupt huge markets like smartphones, tablets, and potentially television. But Google's Overall Quadrix score has dropped to 59, hurt by a sharp decline in the Earnings Estimates score. While the Overall score should rebound a bit as profit estimates stabilize, the stock is no longer among our very top picks.

6 STRATEGIES: SELLING BASED ON OVERALL SCORES
Below are returns and volatility (standard deviation) numbers for six strategies, all based on rolling 12-month periods for S&P 1500 stocks since 1994. No. 1 buys all the stocks in the S&P 1500. No. 2 buys the top 10% of S&P 1500 stocks based on Overall Quadrix scores (about 140 stocks, on average). No. 3 also starts with the top 10% based on Overall score, but it reviews stocks monthly and drops any for which the Overall score moves below 80. No. 4 only sells a stock if its Overall score drops below 60, and so on. On average, No. 3 results in 73 stocks being dropped over each 12-month period.
1
2
3
4
5
6
Initial Portfolio
All Of
S&P
1500
-- Top 10% of S&P 1500 Stocks On Overall Score --
Monthly review
No
No
Yes
Yes
Yes
Yes
Sell if Overall score:
NA
NA
Below 80
Below 60
Below 40
Below 20
Avg. 12-mo. return (%)
12.9
17.7
19.2
18.2
17.8
17.6
Standard deviation (%)
20.4
20.9
21.3
20.7
20.6
20.6
% of up 12-month periods
78
84
84
83
83
83
Avg. number of sales
0
0
73
31
11
3

 

9 STRATEGIES: SELLING BASED ON CATEGORY SCORES
Below are returns and volatility (standard deviation) numbers for nine strategies, all based on rolling 12-month periods for S&P 1500 stocks since 1994. No. 1 buys all S&P 1500 stocks. No. 2 buys the top 20% on Overall Quadrix score (about 286 stocks, on average). No. 3 also starts with the top 20% based on Overall score, but it reviews stocks monthly and drops any for which the Overall score moves below 40. No. 4 sells any stock if its Momentum score is below 40, while No. 5 sells if the Value score is below 40. Only No. 4 and No. 5 improved much on No. 2, partly because few stocks saw Overall scores drop below 40.
1
2
3
4
5
6
7
8
9
Initial Portfolio
All Of
S&P
1500
--------------------------- Top 10% of S&P 1500 Stocks On Overall Score ---------------------------
Monthly review
No
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Sell if score below 40 on:
NA
NA
Overall
Momen-
tum
Value
Quality
Fin.
Strength
Earns.
Ests.
Perfor-
mance
Avg. 12-mo. return (%)
12.9
16.3
16.4
17.0
17.1
16.2
16.3
15.1
14.8
Standard deviation (%)
20.4
18.9
18.7
18.7
20.4
18.7
18.6
18.7
17.6
% of up 12-mo. periods
78
84
84
85
82
83
84
83
84
Avg. number of sales
0
0
25
125
84
14
34
127
216

 

 


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