In search of selling triggers

10/20/2008


We’ve written extensively about how the Quadrix stock-rating system can help you find stocks to buy. Today we’re tackling a different issue — how Quadrix can help you sell.

We tested a variety of sell triggers, including strategies based on declines in Quadrix scores, declines in stock prices, and weak share-price performance relative to the market. All three of those strategies make intuitive sense. Two of them actually work.

As the chart below illustrates, portfolios that sold stocks after the Overall score dipped below 80 averaged a 12-month return of 20.0%, versus the 18.4% return for buy-and-hold portfolios. A strategy of selling stocks that lagged the S&P 1500 Index by 10% over a three-month period averaged a 19.1% return.

While we did find sell triggers that enhanced returns, several had the opposite effect. Here are some of the most interesting tips gleaned from our research:

Have patience with performance. Portfolios that sold stocks after they declined 10% or 20% lagged the buy-and-hold strategy. Such a strategy would get investors out of many stocks during periods of market weakness, regardless of the individual appeal of the stocks. Actionable advice: Don’t panic when stocks fall for no reason other than that the market is weak. Many stocks can recover and earn solid returns after such declines.

Watch for falling Quadrix scores. We at the Forecasts prefer to focus on our best investments. To us, when a stock’s Overall score dips below 80, it’s a signal to take a close look at a stock — and look for a replacement with better prospects. While the Forecasts sometimes holds onto stocks after their Overall scores fall for diversification purposes or because we believe unusual factors have temporarily depressed the rank, we prefer to stick with stocks that score at least 80. Portfolios that dumped stocks after Overall scores fell below 50 also beat the buy-and-hold portfolio, but not by much. Actionable advice: Pay attention to changes in Quadrix scores. Consider a drop below 80 in Overall score a cue to take a closer look at a stock.

Value signal works. Typically, the Forecasts excludes from buy consideration any stocks with Value, Earnings Estimates, or Performance scores below 20, regardless of the Overall score. We tested strategies that involve dropping stocks after one of those scores dips below 20. Two of the strategies lagged, but portfolios that dumped low Value scorers averaged an 18.5% return, slightly higher than the buy-and-hold return. Actionable advice: Be careful with stocks that get ahead of themselves. A Value score below 20 could be a sign of trouble ahead.

All of the information above is based on a back-test of the top 10% of the S&P 1500 Index as measured by Overall score, for rolling 12-month periods since 1994. Three recommended stocks with solid Overall scores and Value scores of at least 40 are reviewed below:

Following favorable court settlements in the June quarter, AstraZeneca ($41; NYSE: AZN) faces no new generic competition over the next two years. The company has 11 drugs each providing at least $1 billion in annual revenue, all but two of which saw sales rise in the six months ended June. Strong growth from those blockbusters, coupled with a robust cost-cutting program, should help AstraZeneca exceed consensus estimates in the year ahead. AstraZeneca is working to cut more than $1 billion in annual costs.

The British drugmaker boasts a solid pipeline of more than 100 potential therapies, with 34 in phase III trials, the final stage of testing. Diabetes drug Onglyza, which has been submitted to the U.S. Food and Drug Administration, looks especially promising. Recent studies have also shown a new cholesterol drug and a cancer treatment outperformed rivals. AstraZeneca topped consensus profit estimates by 15% in the June quarter, marking the sixth consecutive positive profit surprise. AstraZeneca sells for just eight times expected 2008 earnings, and estimates are on the rise. AstraZeneca is a Long-Term Buy.


The possibility of a slowdown in consumer spending on personal computers poses a significant challenge to Hewlett-Packard ($40; NYSE: HPQ). Still, the company enjoys plenty of competitive advantages in a slow economy. The personal-computer division is H-P’s second-largest unit, providing 34% of revenue. Yet, while consumers may become more frugal in coming months, H-P says businesses have been restrained in their technology purchases over the last year, and demand for computer equipment remains solid.

H-P generates nearly 65% of its revenue overseas. Less than 10% of revenue comes from financial-services firms. With nearly $15 billion in cash at the end of July and sufficient financial strength to borrow money despite the credit crunch, H-P is well-positioned to weather the downturn. The stock sells for just 10 times projected year-ahead earnings, well below its five-year average forward P/E of 14. H-P is a Buy and a Long-Term Buy.


In a market where credit is scarce, Microsoft’s ($24; NASDAQ: MSFT) financial strength, growth potential, and defensive qualities separate it from the crowd. Microsoft seems well-prepared to deal with a slow or contracting economy. Nearly half of its revenues are recurring, and exposure to the troubled financial sector is limited.

The growth picture remains bright. New software releases from the last 18 months should help sustain revenue growth in the years ahead. A new version of the Windows operating system is scheduled for release in 2010, followed by an upgrade of the Office suite of business software.

Despite its growth opportunities and defensive traits — a $26 billion cash hoard and impressive cash flow — Microsoft trades at 11 times expected earnings in fiscal 2009 ending June. The company is slated to release September-quarter results Oct. 23. Microsoft is a Buy and a Long-Term Buy.

QUADRIX LEADERS
—— Total Return ——
—— P/E Ratio ——
Est. EPS
——Growth ——
Quadrix
—– Scores * —–
Company (Price; Ticker)
Div.
($)
Yield
(%)
Mkt.
Value
($Mil.)
1 Mo.
(%)
3 Mos.
(%)
12 Mos.
(%)
Trailing
Trailing
Over
5-Yr.
Avg.
Curr.
Fiscal
Year
(%)
Next
Fiscal
Year
(%)
Value
Overall
Advice
Accenture
($33; ACN)
0.50
1.5
20,229
(7)
(13)
(17)
12
0.66
9
10
66
95
Focus
Buy †
AstraZeneca
($41; AZN)
1.90
4.7
58,577
(10)
(10)
(18)
9
0.50
5
5
72
83
LT Buy
DirecTV ($22; DTV)
0.00
0.0
24,566
(16)
(15)
(16)
17
NM
22
32
47
85
Focus
Buy
Disney ($26; DIS)
0.35
1.4
48,187
(21)
(13)
(26)
11
0.54
21
6
63
79
LT Buy
Exxon Mobil
($72; XOM)
1.60
2.2
376,357
(1)
(11)
(22)
9
0.69
24
2
74
92
LT Buy
Hewlett-Packard
($40; HPQ)
0.32
0.8
99,115
(11)
(3)
(21)
12
0.65
23
14
65
87
Buy †
Lockheed Martin
($96; LMT)
2.28
2.4
37,959
(14)
(5)
(12)
13
0.71
9
9
49
88
Focus
Buy †
Microsoft
($24; MSFT)
0.52
2.2
218,237
(10)
(7)
(19)
13
0.55
14
13
62
89
Buy †
Oracle ($18; ORCL)
0.00
0.0
91,182
(7)
(13)
(19)
13
0.57
17
13
52
88
Buy †
St. Jude Medical
($38; STJ)
0.00
0.0
12,903
(11)
(14)
(18)
18
0.63
25
13
40
81
Focus
Buy †
* Quadrix scores are percentile ranks, with 100 the best.      † Also qualifies as a Long-Term Buy.      NM Not meaningful.


Tough Sell
Selecting buy candidates isn’t easy.But it’s a lot easier than selling, for several reasons:

Tough to cut ties. As investors, we buy stocks we like. And it is easy to hold them long after their investment appeal dims, since we still like them. Thus is born the stock collector, who over time builds up a personal index fund.

Losing perspective: Money managers have a saying about how individual investors view the market: “all gains are permanent, all losses are temporary.” Logic tells us the statement is not true, but it is human nature to congratulate ourselves for our successes and come up with justifications for our failures. From such loss of perspective, investment disasters spring.

Fighting the last war. Nobody likes to lose. After a stock falls — even if you know it fell for good reason and is no longer a good investment — there’s a temptation to stick with it to “get your money back.” Unfortunately, many stocks fall for good reasons and are likely to stay down. The wise move is often to take the loss, to bail on a stock once it no longer represents a good investment at current prices.


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