A Premium For Value

9/29/2014


Following up a 30% price gain in 2013, the S&P 1500 Index has cruised to one all-time high after another on its way to a 7% rise this year.

Partly as a result, just 22% of S&P 1500 stocks trade below their five-year median price/earnings ratio, compared to an average of 40% since December 1994. Stocks available at discounts to their five-year median price/sales ratio (currently 24%, vs. average of 48%) and price/cash flow ratio (27%, 41%) are also fairly scarce.


VALUE RELATIVELY TOUGH TO FIND

Just 323 stocks in the S&P 1500 Index currently trade at a discount to their five-year median price/earnings ratio, well off the average of 595 since December 1994.

Number Of Stocks Below
5-Year Median
Price/
Earnings
Price/
Sales
Price/
Cash Flow
Current
323
361
401
Average
595
723
615
Maximum
1,075
1,415
1,179
Minimum
197
244
277

For all three ratios, less than 11% of months since December 1994 had fewer stocks trading at a discount to five-year medians.

Investors tend to bid up assets that are increasingly in short supply. With low valuations now scarce, the Quadrix Value score is proving highly effective. In the past 12 rolling 12-month periods, S&P 1500 stocks scoring in the top quintile for Value outperformed the average stock by 7.7%, much better than the Overall score's 2.5% excess return. The Value score has delivered an average excess return of 4.9% over the past five years.

Among relative valuation ratios, price/earnings to five-year median, price/sales to five-year median, and price/cash flow to five-year median have worked well over the past one-, five-, and 10-year periods.

QUADRIX VALUATION FACTORS WORK WELL
Excess Returns Of Top-Scoring Quintile of S&P 1500
---------------------------------- (Rank Among Quadrix Factors) ----------------------------------
-- Price/Earnings Ratio --
-- Price/Cash Flow Ratio --
--- Price/Sales Ratio ---
Trailing
Vs. 5-Yr.
Median
Trailing
Vs. 5-Yr.
Median
Trailing
Vs. 5-Yr.
Median
Last 10 Years
1.8
(8)
1.7
(10)
3.4
(3)
0.8
(21)
4.5
(1)
2.0
(6)
Last 5 Years
4.1
(15)
3.5
(18)
4.2
(14)
2.8
(23)
8.0
(1)
7.7
(2)
Last 1 Year
5.0
(8)
3.6
(16)
5.6
(7)
3.7
(14)
6.6
(3)
5.1
(9)

Investors shouldn't stop their analysis at relative valuations. Stocks with the lowest P/E, P/S, and P/CF ratios on an absolute basis tend to perform even better than stocks with attractive relative valuations. All three ratios rank among the top 15 most effective Quadrix factors for one-, five-, and 10-year periods.

The table below lists stocks that trade at a discount to historical norms on at least one metric; most look cheap on an absolute basis as well. All earn decent Value scores.

EOG Resources' ($102; EOG) Value score of 66 is lower than that of most other stocks in the page 5 table. Some of its key valuation ratios look high relative to other stocks but seem more reasonable given the oil producer's historical norms. EOG's P/E ratio of 20 is below its five-year median of 39, while the price/sales ratio of 3.6 is in line with its 10-year median.

Shares have pulled back 13% since the end of June, though the company enjoys strong operating momentum. Total production rose 18% in the six months ended June, causing management to raise its full-year production guidance in August. Cash from operations has advanced in 13 of the past 14 quarters, including 37% growth over the 12 months ended June. Weakening oil prices have sparked some analysts to lower expectations, but the consensus still projects sales growth of 18% this year and 11% next year, with per-share profits up 37% this year and 12% next year. EOG is a Buy and Long-Term Buy.


ManpowerGroup ($74; MAN) looks cheap from nearly every angle, earning above-average ranks for more than three quarters of the Quadrix factors that go into its Value score of 89. The stock trades more than 18% below five-year medians for price/earnings and price/cash flow; its scores for both of these factors rank in the top 20% of our research universe. Although Manpower's price/sales ratio looks high relative to historical norms, just 6% of stocks in our research universe have a lower ratio on an absolute basis.

Manpower offers an appealing blend of cheap valuation and strong operating momentum. Operating profit margins are trending upward. In the June quarter, Manpower posted its strongest sales growth since the September 2011 quarter. The consensus projects 20% higher per-share growth in the September quarter on 6% revenue growth. Manpower, earning a Momentum score of 94, is a Focus List Buy and a Long-Term Buy.


Packaging Corp. of America ($64; PKG) shares trade at 15 times trailing earnings, 17% below their five-year median — just 13% of stocks in our research universe trade at a steeper discount. Even if the P/E remains at its current level, the stock stands to rally 11% by early next year if the company meets the current consensus 2014 earnings estimate. Analysts expect per-share profits of $4.66, implying 42% growth.

PCA is one of the largest U.S. manufacturers of packaging products, containerboard, and white paper. An improving U.S. economy and growth in online commerce should support higher demand for shipping containers and retail boxes in coming quarters. For instance, bellwether FedEx ($159; FDX) said earlier this month it expects the upcoming holiday season to bring record shipments. Meanwhile, UPS ($98; UPS) plans to boost seasonal hiring 64% to 73% above last year's levels. PCA, yielding 2.5%, is a Buy and a Long-Term Buy.


Schlumberger ($102; SLB) shares have shed 7% since management warned on Aug. 12 that sanctions on Russia would hurt September-quarter profits. Russia generates just 4% to 5% of the company's revenue but has helped drive recent growth. Still, Schlumberger has delivered eight straight quarters of double-digit growth in cash from operations, improving our confidence that favorable trends in operating profits are sustainable.

September-quarter earnings per share are projected to climb 15% to $1.48 on 9% higher revenue. The stock's trailing P/E ratio of 20 is 5% below its five-year median. Should Schlumberger match the current consensus 2014 profit estimate of $5.67 per share and its P/E ratio hold at 20, its shares will advance 9% by early 2015. Looking further out, management targets per-share earnings of $9 to $10 in 2017. Schlumberger is a Focus List Buy and a Long-Term Buy.

STOCKS SERVING UP DISCOUNTS
We screened for recommended stocks trading at a discount to five-year norms on at least one of the following: price/earnings, price/sales, or price/cash flow. The stocks are not necessarily sluggards, as all trade within 20% of their 52-week highs and earn decent Quadrix Momentum scores.
Price/Earnings
------ Ratio ------
Price/Sales
------ Ratio ------
Price/Cash Flow
------ Ratio ------
Stock
Discount
To 52-
Week High
(%)
--------- Quadrix Scores ---------
Company (Price; Ticker)
Current
Versus
5-Year
Median
Current
Versus
5-Year
Median
Current
Versus
5-Year
Median
Momen-
tum
Value
Overall
Apple ($102; AAPL)
16.4
1.08
3.46
0.97
13.5
1.00
(1)
72
73
98
Cognizant Tech. ($45; CTSH)
18.7
0.77
2.88
0.82
17.8
0.85
(18)
59
72
79
EOG Resources ($102; EOG)
20.4
0.54
3.62
1.02
8.5
1.10
(15)
83
66
81
ManpowerGroup ($74; MAN)
14.9
0.81
0.29
1.27
12.6
0.78
(16)
94
89
96
Packaging Corp. ($64; PKG)
15.3
0.83
1.24
1.07
7.8
0.94
(14)
85
89
95
Qualcomm ($76; QCOM)
15.9
0.79
4.97
0.87
15.5
0.91
(7)
55
77
91
Quanta Services ($37; PWR)
21.2
0.93
1.15
1.06
13.9
1.03
(2)
49
54
68
Schlumberger ($102; SLB)
19.6
0.95
2.87
1.02
12.7
1.02
(14)
77
68
84
Note: Quadrix scores are percentile ranks, with 100 the best.

 


Absolute and relative values

What stocks look cheap on both an absolute and relative basis? First we screened for stocks in the S&P 1500 Index's lowest decile for price/earnings, price/sales, and price/cash flow ratios.

Number Of Stocks Trading
---------- At A Discount To ----------
5-Year
Median
Industry
Median
Both
Price/Earnings
89
140
88
Price/Sales
62
139
61
Price/Cash Flow
78
135
73

Just seven stocks ranked in the lowest 10% for all three ratios. The Forecasts follows only one, A-rated Valero Energy ($47; VLO).

Check out stocks in the cheapest declile at www.DowTheory.com/Go/Ratio. We target growth at a good price rather than deep values, and only six of our recommended stocks are in one of the bottom deciles.

We then considered the cheapest stocks' valuations relative to their own five-year and industry medians. For example, among the 150 stocks in the bottom decile for price/earnings, 88 also trade below their historical and industry norms. None of our six low-valuation stocks fetch a discount to five-year medians, though four look good relative to their industries.

Of our recommended stocks, only Aetna ($84; AET), Capital One Financial ($82; COF), and J.P. Morgan Chase ($62; JPM) ranked in the lowest decile for P/E. Both Aetna and J.P. Morgan trade below their industry median P/Es.

Stocks with the lowest price/sales ratios include Aetna and Kroger ($53; KR), a Focus List Buy and a Long-Term Buy. Kroger's P/S ratio is below the median for S&P 1500 food retailers.

Alaska Air Group ($45; ALK), Kroger, and United Rentals ($114; URI) rank among the cheapest stocks relative to cash flow. Kroger and United Rentals also look cheap relative to peer-group medians.


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