No Size Discrimination With Quadrix

1/27/2014


Our Quadrix stock-rating system can sniff out outperforming stocks of all sizes. We tested 12-month returns of stocks in four size categories — large-cap, midcap, small-cap, and microcap — and found that those with high Overall scores delivered superior returns for all groups.

In the large-cap, midcap and small-cap segments, the top one-fifth of Overall scorers averaged returns at least four percentage points above the average for their size group. The six categories that combine to derive the Overall score had predictive power in most size categories, but Value (price/earnings and other valuation ratios) and Performance (stock-price action) were among the two most effective scores in three of the four groups.

BIG OR SMALL, QUADRIX WORKS FOR ALL
In the large-cap, midcap, small-cap, and microcap groups, the top quintile (one-fifth) based on Overall score has outperformed the average stock in 12-month periods since the start of 1990. The numbers in bold reflect the two most effective category scores for each group.
----Average 12-Month Return Of Top Quintile Based On ----
Stock-Market Value Groupings For Quadrix Universe
12-Mo.
Return Of
Average
Stock
(%)
Momen-
tum
(%)
Value
(%)
Quality
(%)
Fin'l
Str.
(%)
Earns.
Ests.
(%)
Perfor-
mance
(%)
Overall
(%)
Large-caps ($12.74
bil. or larger)
12
13
14
14
13
13
15
16
Midcaps ($2.96 bil.
to $12.74 bil.)
13
16
17
15
14
14
16
18
Small-caps ($781
mil. to $2.96 bil.)
13
15
18
15
15
14
15
18
Microcaps ($781
mil. or smaller)
21
24
25
18
18
23
22
22

To slice the market into size categories, we started with the more than 1,900 companies listed on the New York Stock Exchange and divided them into deciles (tenths) by stock-market value. Then we slotted the other roughly 2,700 companies in our Quadrix universe into those deciles. Decile 1 contains the largest stocks, Decile 10 the smallest. We classified deciles 1 and 2 as large-cap, 3 through 5 as midcap, 6 through 8 as small-cap, and 9 and 10 as microcap.

Most of the stocks traded on U.S. exchanges aren't very large. As of Jan. 21, small-caps and microcaps (market values of $2.96 billion or smaller) made up 72% of the stocks but only 7% of the total market capitalization. The disparity brings to light three important truths about stock investing.

1) The 11% of stocks that qualify as large-caps account for more than three-fourths of our research universe's total capitalization, which means they exert outsized influence on the market. Most broad indexes weighted by market capitalization reflect what's happening with large-caps, which may mask developments with smaller stocks.

2) Dow Theory Forecasts' focus on large-caps and selected midcaps limits us to a fairly small number of stocks. Fortunately, those stocks have better fundamentals — higher Quadrix scores — than smaller companies, as shown in the table below. Large-caps have historically averaged higher scores for Overall (62) and all six category scores than the average for the universe, which is always 50. On average, Overall, Value, and Quality scores tend to improve incrementally as the stocks get larger.

TOP STOCKS OF ALL SIZES
Stocks from the Upside newsletter are listed in bold.
12-Month
---- Growth ----
----------------------------- Quadrix Scores -----------------------------
Company (Price; Ticker)

Stock-
Market
Value
($Mil.)

Div.
Yield
(%)
Trailing
P/E Ratio
Sales
(%)
Per-
Share
Profits
(%)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
Large-caps ($12.74 billion or larger)
Cognizant Technology
($99; CTSH)
29,923
0.000
24
19
18
92
47
98
93
30
79
89
Comcast ($53; CMCSa)
138,060
1.500
23
3
11
65
62
87
70
80
77
91
Google ($1,164; GOOG)
322,021
0.000
27
24
9
80
30
95
93
95
82
86
Macy's ($56; M)
20,473
1.800
15
4
22
72
83
88
43
92
73
98
Average for large-caps
48,456
2.300
20
6
5
54
61
64
60
52
49
63
Midcaps ($2.96 billion to $12.74 billion)
Credit Acceptance
($139; CACC)
3,203
0.000
14
13
26
92
80
97
78
95
74
100
Helmerich & Payne
($87; HP)
9,348
2.900
15
7
26
77
76
92
96
97
78
99
Skyworks Solutions
($31; SWKS)
5,882
0.000
13
13
42
95
85
95
87
81
80
100
Trinity Industries
($58; TRN)
4,553
1.000
14
10
50
98
86
77
45
99
82
99
Average for midcaps
6,025
1.700
22
9
8
56
55
62
54
51
51
59
Small-caps ($781 million to $2.96 billion)
Och-Ziff Capital Mgmt.
($16; OZM)
2,477
6.500
10
118
(73)
86
75
60
88
99
94
97
Smith & Wesson
($14; SWHC)
805
0.000
10
25
58
90
92
98
74
82
91
100
Synaptics ($58; SYNA)
1,929
0.000
14
40
134
91
71
97
90
83
83
99
Tesco ($20; TESO)
794
0.000
18
(9)
12
83
68
69
64
42
87
89
Average for small-caps 
1,608
1.500
24
10
1
52
49
55
52
49
51
52
Microcaps ($781 million or smaller)
Center Bancorp
($19; CNBC)
313
1.600
16
NA
20
88
63
76
87
88
82
95
Consumer Portfolio Svcs.
($9; CPSS)
206
0.000
15
25
150
97
76
89
51
71
88
98
Dynamic Materials
($22; BOOM)
306
0.700
24
4
2
89
75
56
69
54
64
89
Marlin Business Svcs.
($28; MRLN)
368
1.600
22
19
61
93
62
79
91
77
82
95
Average for microcaps
243
1.100
22
2
(2)
46
47
41
45
50
50
43
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not available.

3) Our sister newsletter Upside taps into the higher-potential — and higher-risk — world of small stocks. While the average small-cap or microcap looks less impressive statistically than the average large-cap, we have plenty of stocks to choose from, and we don't settle for the average.  

The table above presents a few top selections from the four market-capitalization groups. One company from each group is reviewed briefly below.

Large-cap

The last time Cognizant Technology Solutions ($99; CTSH) failed to grow quarterly sales at least 10% was the period ended March 2002. In the 12 months ended September, Cognizant managed growth of 19% in sales, 18% in per-share profits, and 17% in operating cash flow. Demand for Cognizant's outsourcing remained strong throughout the recession — saving money never really goes out of style — and expectations are still high.

The shares aren't cheap, trading at 24 times trailing earnings. But Cognizant's consistent growth, reflected by a Quadrix Quality score of 98, warrants a premium price. The stock is a Focus List Buy and a Long-Term Buy.

Midcap

Helmerich & Payne ($87; HP) earns an Overall score of 99, with all six of the category scores that derive the Overall score above 75. The U.S. drilling-rig market is oversupplied at the moment, but H&P continues to deliver decent growth. The company's technological advantages, particularly a fleet containing mostly high-tech rigs capable of horizontal drilling into shale formations, allow the company to enjoy higher rig utilization and pricing power than its rivals.

Oversupply aside, the consensus target of less than 6% growth in per-share profits this year seems overly conservative, given continued interest in shale drilling. H&P is a Focus List Buy and a Long-Term Buy.

Small-cap

Och-Ziff Capital Management ($16; OZM), a partnership, yields 6.5%. At the end of September, the hedge-fund manager controlled $37.8 billion in assets, up 16% from a year earlier. Och-Ziff dips into a variety of asset classes other than traditional stocks and bonds, including private equity and real estate.

The partnership structure allows Och-Ziff to avoid taxation at the corporate level and pass on most of its earnings to shareholders, thus the high yield. However, partnership dividends require specialized tax treatment; investors will receive a K-1 form. Och-Ziff is a Best Buy in Upside.

Microcap

Marlin Business Services ($28; MRLN) has delivered sales growth of at least 16% and per-share-profit growth of at least 33% in each of the last five quarters. Over the last year, operating cash flow has more than doubled. Analysts expect per-share profits to rise 28% in 2014 on top of a nearly 50% increase in 2013.

The company provides equipment leases to businesses, focusing on small deals; the average transaction is less than $10,000. Business investment has picked up modestly in recent months, and continued economic improvement should support solid demand for leasing in coming quarters. Marlin is rated Best Buy in Upside.

SMALL STOCKS, BIG RETURNS — AND BIG RISKS
Based on calendar-year returns from 1926 through 2012, both average return and the standard deviation of those returns (a measure of volatility) increase as the stocks get smaller. While the tiniest stocks delivered by far the best returns, they also showed the most volatility, posting a lower reward/risk (return/standard deviation) ratio than any other decile. Large-caps and the biggest midcaps offer the best blend of risk and reward. For most investors, a diversified mix of large, midsize, small, and microcap stocks makes sense.
------------------------------------ Number Of Years With ------------------------------------
Decile
Average
Annual
Return
(%)
Standard
Deviation
Of Returns
(%)
Ratio Of
Reward/
Risk
Gains Of At
Least 50%
Gains Of At
Least 25%
Gains Of
Any Size
Declines Of
Any Size
Declines Of
At Least 25%
Declines Of
At Least 50%
Large-caps
1 (largest)
10.9
19.1
0.57
0
21
66
21
4
0
2
12.8
22.0
0.58
2
25
66
21
4
1
Midcaps
3
13.4
23.6
0.57
5
28
64
23
4
0
4
13.8
25.8
0.53
5
27
63
24
7
0
5
14.6
26.6
0.55
9
30
59
28
6
0
Small-caps
6
14.8
27.2
0.54
8
30
63
24
7
1
7
15.2
29.4
0.52
11
31
56
31
7
0
8
16.3
34.0
0.48
11
33
59
28
6
1
Microcaps

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