Searching For Strength

7/21/2014


Readers sometimes ask whether they should buy growth stocks or value stocks. Today the answer is clear: Yes.

For the 12 months ended June 30, stocks with strong operating momentum have excelled, with the top quintile (one-fifth) of the Dow Jones U.S. Index as measured by Quadrix Momentum outperforming by an average of 3.8%. Value stocks did even better, with top Quadrix Value scorers delivering 5.7% outperformance.

THE MARKET FROM MANY ANGLES
We broke down the Dow Jones U.S. Index into segments in search of areas with fundamental strength. We found higher-than-average Quadrix Overall scores among stocks with superior sales and profit growth over the last 12 months, stocks with lower-than-average price/earnings and price/sales ratios, and large stocks.
No. Of
Stocks
Avg.
Market
Cap.
($Bil.)
Avg. Valuation Ratios
Avg. 12-Mo.
-- Growth --
------------------------ Average Quadrix Score ------------------------
Price/
Earnings
Price/
Book
Price/
Sales
Sales
(%)
EPS
(%)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
Dow Jones
U.S. Index
1,257
17.3
22
3.4
2.9
8
8
57
56
64
58
53
55
62
Growth
Sales Growth
Above Avg.
507
13.9
25
4.0
3.8
22
14
67
50
68
58
54
55
63
EPS Growth
Above Avg.
745
16.6
22
3.7
3.0
10
27
65
54
66
56
55
56
65
Both Above Avg.
362
13.5
25
4.2
3.8
22
30
72
49
70
59
56
55
66
Both Above 10%
182
13.0
25
4.4
3.7
21
34
75
53
80
66
57
56
74
Valuation
Low P/E Ratios
733
21.2
16
2.8
2.0
6
9
54
71
66
60
52
53
70
Low P/S Ratios
799
15.0
19
3.0
1.4
6
7
54
66
63
52
51
53
65
Low P/B Ratios
750
14.5
20
2.0
2.3
7
6
54
64
57
57
51
54
62
All Three
Below Avg.
277
16.9
16
1.9
1.3
5
8
52
76
61
56
51
51
70
Index Style Category
Growth Stocks
471
15.8
26
4.8
3.7
15
14
62
47
75
61
53
52
63
Neutral Stocks
230
14.8
21
3.4
2.3
5
4
53
56
63
55
52
56
60
Value Stocks
556
19.6
19
2.3
2.4
4
4
54
64
54
56
53
57
62
Market Cap
Above $50
billion
93
120.5
20
4.2
3.2
6
11
59
60
73
67
54
59
70
$10 billion to
$50 billion
328
21.2
22
3.7
3.1
8
10
60
54
67
60
55
61
64
$5 billion to
$10 billion
279
7.1
22
3.7
3.0
11
11
59
55
66
57
53
58
64
$3 billion to
$5 billion
257
4.0
22
3.3
2.6
9
9
57
56
64
55
53
53
61
Up to $3 billion
300
2.1
22
2.7
2.5
6
(1)
50
59
54
55
50
45
55
Note: Quadrix scores are percentile ranks, with 100 the best.

In the wake of a strong year for stocks (average 12-month returns of 17% for Dow Jones U.S. Index components) and for our Quadrix system (average 12-month outperformance of 4.8% for high Overall scorers), we're digging into the market to find which segments look best. This week's feature story considers stocks from three angles.

Growth and value

To compare growth and value, we used the Dow Jones U.S. Index, which classifies its members as growth, value, or neutral.

Not surprisingly, stocks in the growth category average higher Momentum scores, while value stocks hold the edge in Value. Both groups average Overall scores in the low 60s, suggesting neither has a strong fundamental advantage over the other. Dow Jones uses six metrics — trailing and projected price/earnings, trailing price/book, trailing and projected earnings growth, and dividend yield — to slot stocks.

The Forecasts uses a growth-at-a-good-price philosophy to select investment opportunities, and we're agnostic about their category. You won't find many distressed companies with dirt-cheap valuations on our buy lists; nor will the fastest growers typically make the cut. Both types of stocks tend to earn lopsided Quadrix scores, ranking well in some areas and poorly in others. Most of the stocks we recommend have appeal on both the growth and value sides — think of them as growth stocks with attractive prices or value stocks with solid growth potential.

Viewed through the lens of specific growth statistics or valuation metrics, we find a tale of haves and have-nots. Stocks with price/earnings or price/sales ratios below the index average earn higher Overall scores, while those with trailing 12-month sales and profit growth above the index average also earn superior Overall scores. Boost the growth requirement to 10% (versus the current 8% average for both sales and earnings), and stocks average Overall scores of 74.

Bottom line: While neither growth nor value as a category possesses a notable advantage, stocks that look good based on both valuations and growth rates tend to outperform.

Large and small

Based on Quadrix Overall scores, bigger is better. Dow Jones U.S. Index components with stock-market values above $50 billion average Overall ranks of 70, while those from $5 billion to $50 billion also score better than the index average. In contrast, stocks with market capitalizations below $5 billion earn subpar scores. The biggest stocks also earn top marks in Value, Quality, and Financial Strength and exceed the index average for Momentum.

Does this mean investors should forget about small stocks? Not at all. Small stocks tend to outperform large stocks over long periods of time, and the sheer number of small stocks means most of the market's best opportunities are typically not blue chips. Our sister newsletter Upside has delivered outstanding performance in recent years by ferreting out small stocks with appeal.

Just because a portion of the market scores poorly in Quadrix does not mean you should ignore it. Plenty of small stocks have solid fundamentals, and our stock-rating system can separate the wheat from the chaff.

However, the Dow Theory Forecasts recommended lists tend to skew big. Given the fundamental strength of large-caps and our lists' trouncing of the S&P 500 Index so far this year (see www.DowTheory.com/Performance for details), we're happy with our position. Our recommendations average a market capitalization of $75 billion. Fifteen of the stocks are above $50 billion, and none are below $5 billion.

Bottom line: Today large-caps boast the best fundamentals, and our approach mostly keeps us fishing in that appealing pond.

Sector and industry

Stocks in the consumer goods, consumer services, industrials, oil & gas, and utility sectors average Overall scores above the index average of 62. The rest are in the 50s or low 60s, except for telecom, which averages 42.

Averages for the five highest-scoring sectors are tightly packed in a range of 64 to 67, suggesting none boasts substantially better fundamentals than the rest. However, averages for industry groups within the sectors show more delineation.

Only two of the 25 industry groups average Quadrix scores of 70 or more, and we recommend stocks in three of them — automobiles and parts, industrial transportation, and oil & gas producers. In contrast, six industries — mining, real estate, industrial metals, drugs and biotech, tobacco, and forestry and paper — average Overall scores below 50. We recommend no stocks in those six groups.

Check out the table below for a list of sectors and industries, along with 18 recommended stocks in some of the high-scoring industries.

Bottom line: Don't limit yourself to sectors or industries with high scores. After all, you're buying individual stocks, not sectors. Still, it is easier to unearth attractive stocks in groups with strong Overall scores.

SECTOR/INDUSTRY ANALYSIS
All data for sectors and industries represent averages, except for the number of stocks. Top-scoring industries (Overall ranks 67 or higher) are listed in bold, with individual stocks if we recommend any in the group.
Sector (No. Of Cos.)
Industry (No. Of Cos.)
Company (Price; Ticker)
--- Avg. Valuation Ratios ---
Avg. 12-Mo.
---- Growth ----
Avg.
Quadrix
Overall
Score
Price/
Earnings
Price/
Book
Price/
Sales
Sales
(%)
EPS
(%)
Consumer Goods (117)
20.7
4.3
2.0
11
13
65
   Automobiles & Parts (19)
16.6
3.8
1.8
7
20
84
     Lear ($95; LEA)
14.8
2.5
0.5
12
17
95
     Magna Int'l ($111; MGA)
14.5
2.5
0.7
12
36
99
   Beverages (8)
22.3
6.0
3.4
3
21
69
   Food Producers (28)
24.5
4.2
1.7
7
3
55
   Household Goods (24)
18.7
3.0
1.5
19
25
63
   Leisure Goods (11)
19.5
5.1
2.0
15
2
69
   Personal Goods (22)
22.2
5.3
2.4
12
10
65
   Tobacco (5)
17.7
3.7
3.5
2
(4)
48
Consumer Services (186)
21.7
4.3
1.8
7
8
64
   Food & Drug Retailers (17)
21.3
3.8
0.6
8
0
56
   General Retailers (80)
18.9
3.9
1.4
5
(2)
67
   Media (39)
21.5
4.1
2.6
8
11
61
   Travel & Leisure (50)
26.5
5.3
2.4
8
22
64
Financials (267)
22.7
2.2
4.3
7
10
60
   Banks (60)
16.7
1.4
3.5
1
5
59
   Financial Services (49)
20.1
3.4
3.8
12
16
68
     Capital One ($85; COF)
11.6
1.1
2.0
(2)
24
93
     Ameriprise ($122; AMP)
16.3
2.8
2.0
11
25
97
   Life Insurance (13)
12.2
1.2
1.2
(2)
20
85
   Nonlife Insurance (47)
14.0
1.4
1.5
5
12
80
   Real Estate (98)
37.2
2.5
6.7
12
8
43
Health Care (111)
23.0
4.7
3.9
10
6
56
   Drugs & Biotech (50)
26.4
6.4
6.6
12
10
47
   Equipment & Services (61)
21.1
3.6
2.2
8

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