Go For Growth At A Discount

4/7/2014


The Dow Transports and S&P 500 Index, brushing off widespread concerns about sluggish corporate profits and frothy stock valuations, began April with fresh all-time highs. The Dow Industrials have rallied within a few points of their Dec. 31 all-time high of 16,576.66, and a close above that level would reconfirm the bullish primary trend. With the broad market advancing — and our growth-at-good-price approach working nicely — we are keeping 96% to 98% of our buy lists in stocks.

Growth shortage

Investors tend to prize what's in short supply, and the U.S. stock market faces a shortage of high-growth companies. In response, investors have been willing to bid up the shares of rapid growers like the biotechnology group, Amazon.com ($343; AMZN), and Tesla Motors ($230; TSLA) — until recently.

Such richly valued stocks have been under pressure since the beginning of March, as shares of companies with the fastest expected five-year profit growth suffered their worst month of relative performance in more than two years. Shares of deep-discount value stocks have benefited from the shift, helping stocks with the lowest price/earnings and price/cash flow ratios enjoy their best month of relative performance in more than a year.

Also benefiting are shares of attractively valued growers. Shares of companies with low PEG ratios (expected current-year P/E divided by expected five-year growth rate) outperformed handily in March, extending a yearlong run of strong returns. Along the same lines, stocks with high Overall Quadrix scores outperformed in March and over the past year.

Of course, growth-at-a-good-price strategies depend on the availability of growers. Consensus per-share-profit estimates project little or no March-quarter profit growth for the S&P 500 Index, reflecting a near record number of profit warnings. Thomson Reuters says first-quarter estimates call for 2.2% year-to-year growth, while FactSet projects a 0.4% decline.

But those numbers reflect the capitalization-weighted nature of the index. The median S&P 500 company is expected to deliver 5.2% profit growth, meaning one-half of S&P 500 components are expected to deliver at least 5.2% growth. Assuming companies beat consensus profits by 2% to 3% as they have in recent quarters, median earnings growth will approach the 7% to 8% pace of the past three quarters.

Conclusion

While rapid growers are in short supply, we are still finding enough reasonably valued growers to execute our strategy. Top picks include such Overall Quadrix standouts as Magna International ($99; MGA) and Wells Fargo ($50; WFC).


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