Long-Term Forecasts: Wrong, Biased -- Useful?

3/24/2014


For the S&P 1500 Index of small, midsize, and large stocks, companies in all nine of the sectors other than utilities average long-term-growth estimates between 9.4% and 14.7%. Four sectors (health care, technology, consumer discretionary, and energy) are projected to grow between 14.4% and 14.7% per year, homogeneity that rarely occurs in reality.

Given the nature of those sectors and the ongoing economic recovery, we can't quibble too much with the estimates. Yet history suggests at least one of the four sectors will perform a lot worse than expected.

Consider actual profit growth over the previous five years. The spread between high and low is far wider than that of the estimates. Regardless of whether growth speeds or slows, five years from now we will probably see a similarly divergent batch of numbers, including several surprises.

ANATOMY OF A GROWER
Average For
Top Quintile
On Estimated
Profit Growth
Average For
Remaining
S&P 1500
Stocks
Stock-market value (billions of $)
13.3
13.7
Price/earnings ratio
29
21
Price/sales ratio
3.3
2.4
Price/book ratio
4.2
2.9
P/E to growth (PEG)
1.4
1.8
% in cyclical sectors
88
53
5-year annualized growth
Sales (%)
10
4
EPS (%)
10
6
1-year growth
Sales (%)
13
5
EPS (%)
13
6
Quadrix scores
Momentum
60
51
Value
47
60
Quality
71
60
Financial Strength
60
58
Earnings Estimates
48
51
Performance
53
48
Overall
60
59

More important than the ability to predict profit growth is the ability to predict stock returns. And as inaccurate as consensus estimates for long-term growth tend to be, they can help spotlight potential winners.

S&P 1500 stocks in the top quintile (one-fifth) based on estimated long-term profit growth averaged 12-month returns 3.0% above the index average in a back-test since 1994. No other non-Value statistic delivered better performance. In contrast, the top quintile of stocks as measured by actual earnings growth over the previous five years outperformed by an average of 1.2% — not bad, but well below the efficacy of growth estimates.

Among the stocks in the S&P 500 Index, the top quintile on estimated profit growth outperformed by an average of 2.0%, not as good as for the broader index but still among the 10 most effective Quadrix factors for the large-cap index.

Long-term estimated profit growth has predictive power in all 10 sectors of the S&P 1500, though it works best in consumer staples and health care, sectors with defensive characteristics, and worst in technology and industrials, sectors known for cyclicality.

While individual stocks with high expected growth were more likely to underperform than outperform in our back-test, enough of them delivered big returns to drive the average outperformance of the top quintile. That quintile's performance has historically been volatile, no surprise given the nature of stocks with high projected growth — faster-growing than the average stock over the last one and five years, pricier, and more concentrated in cyclical sectors. Among the large-cap stocks in the S&P 500, companies with the very highest growth estimates (20%-plus) have historically lagged those in the sweet spot of 13% to 19%.

Investors should never buy stocks simply because of their high growth estimates. However, in the table below we've presented a few stocks with above-market profit-growth targets plus other attributes that boost our confidence in the estimate:

• High Quadrix Overall scores.

• Solid profit growth over the last 12 months.

• Profit surprises in the last two quarters.

• Rising profit estimates for the current year and next year.

Four intriguing high-growth selections are discussed below:

Alaska Air Group ($93; ALK) keeps expanding beyond its legacy business of shuttling passengers along the West Coast. In recent years, it has added more flights to Hawaii, as well as transcontinental and midcontinent routes. It entered 35 new markets in the past two years alone. Yet Alaska Air generated positive free cash flow in each of the past four years. In that time, it has launched a dividend, reduced the share count by more than 3%, and fully funded its pension plans. The balance sheet holds net cash exceeding $6 per share.

Some challenges still exist — capacity rose 8% in Alaska Air's markets during the December quarter, compared to industrywide growth of 3%. But the company's per-share profits are projected to surge 24% this year, and estimates have steadily risen over the past 90 days. Shares trade at 14 times estimated 2014 earnings, a 10% discount to the median for S&P 1500 airline stocks. Alaska Air, expected to grow profits at an annualized rate of 14% over the next five years, is a Buy.


Magna International ($97; MGA) shares have rallied 8% in the weeks since the auto-parts supplier reported double-digit growth in earnings per share, sales, and operating cash flow for the December quarter. Analyst estimates have sharply risen in recent months, with the consensus currently projecting 9% higher profits in 2014, 17% growth in 2015, and 13% annually over the next five years. The stock scores in the top 10% of our Quadrix research universe for Earnings Estimates.

Operating profit margins climbed to a nine-year high in 2013, even though revenue growth was led by the less-profitable European (up 16%) and Asian (up 31%) units. Europe's profit margins are steadily improving, a trend Magna expects to continue over the next few years as it benefits from restructuring activities that shifted manufacturing to cheaper regions. Management also pushed through a retroactive price hike in Europe during the December quarter. Magna, which has topped consensus profit estimates in nine straight quarters, is a Focus List Buy and a Long-Term Buy.


Raymond James Financial ($53; RJF) is a diversified bank with $447 billion in assets under administration, up 15% from December 2012. Its stable of advisers helps investors manage their wealth and assists institutional clients in issuing stock and acquiring other companies. A rising U.S. stock market has lifted investment-advisory fees and should help fuel continued near-term inflows. Corporate executives are also recovering their appetites for risk. This year the volume of deals announced by U.S. companies jumped to its strongest two-month start since 2000, while the pace of companies filing for initial public offerings is unmatched since the height of the internet boom.

At 17 times trailing earnings, shares trade 16% below the average investment banking and brokerage stock in the S&P 1500 Index. Raymond James, projected to grow profits at a 16% annual rate over the next five years, is a Buy and a Long-Term Buy.


Skyworks Solutions' ($37; SWKS) per-share profits are projected to surge 18% in fiscal 2014 ending September on 12% higher sales, helped by the popularity of smartphones and tablets, which continue to gain traction in emerging markets. The company's growth is also powered by the "internet of things," a catch-all phrase that describes the rising number of homes, cars, medical devices, and even smoke detectors now connected to the web. Skyworks' radio-frequency semiconductors allow these wired products to communicate with each other. The consensus projects annualized profit growth of nearly 17% over the next five years, an aggressive target but one that seems within Skyworks' reach.

Skyworks shares have generated a 74% total return over the last year. Despite that strong price action, the stock still earns a solid Value score of 63 and trades at 14 times estimated profits for fiscal 2014, a steep 39% discount to its peer-group average. Skyworks Solutions, earning a Quadrix score of 99 for Overall and both sector-specific ranks, is a Focus List Buy and a Long-Term Buy.

STOCKS WITH HIGH EXPECTED GROWTH AND MUCH MORE
We screened for A-rated stocks with estimated long-term growth above the S&P 1500 Index average of 12.5%; at least 9% growth over the last year; positive profit surprises in the last two quarters; rising profit estimates for this year and next year; and Quadrix Overall scores of at least 80. Stocks on our buy lists are in bold.
----- Per-Share-Profit Growth -----
-- Profit Surprise --
3-Mo. Chg. In
-- Profit Est. --
------- Quadrix Scores -------
Company (Price; Ticker)

Est.
Next
5 Yrs.
(Annual.)
(%)

Est.
Curr.
Year
(%)
Est.
Next
Year
(%)
Last 12
Months
(%)
Last
Quarter
(%)
Previous
Quarter
(%)
Curr.
Year
(%)
Next
Year
(%)
Momen-
tum
Quality
Overall
Sector
Alaska Air
($93; ALK)
14.2
24
13
24
3.1
3.4
5.1
4.7
88
96
99
Industrials
AutoZone
($538; AZO)
15.3
13
13
19
1.3
0.3
0.8
1.0
86
93
97
Consumer
discretionary
Disney ($82; DIS)
13.5
19
14
19
13.6
1.5
2.4
1.7
80
86
88
Consumer
discretionary
Helmerich & Payne
($103; HP)
14.0
10
9
25
6.8
2.2
7.6
10.2
75
91
97
Energy
Magna Int'l
($97; MGA)
13.2
9
17
35
51.0
13.8
3.2
7.4
86
91
99
Consumer
discretionary
Norfolk Southern
($97; NSC)
13.3
10
13
9
8.9
10.2
0.7
2.2
84
74
92
Industrials
Raymond James
Fin'l
($53; RJF)
15.7
10
12
10
10.8
48.1
3.4
0.8
69
61
81
Financials
SanDisk
($78; SNDK)
25.4
9
5
169
8.1
20.8
0.1
3.5
94
90
99
Technology
Skyworks
($37; SWKS)
16.6
18
12
42
1.4
3.0
1.3
3.6
96
96
99
Technology
Southwest Airlines
($24; LUV)
15.7
23
14
58
14.9
0.4
9.3
10.5
97
90
99
Industrials
Union Pacific
($189; UNP)
13.6
15
13
14
2.5
0.4
0.8
1.5
79
92
94
Industrials
United Rentals
($92; URI)
17.1
25
26
42
8.7
2.3
1.8
4.7
93
92
97
Industrials
Note: Quadrix scores are percentile ranks, with 100 the best.

Coming next month

In the April 28 issue, we take the long-term growth estimate a step further and look at the price/earnings-to-growth (PEG) ratio. The PEG starts with the P/E on estimated current-year earnings, then divides that valuation ratio by the long-term profit growth estimate to measure valuation relative to growth potential.

 


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