What's Working In Quadrix

11/24/2014


Over the years, Value factors have been by far the most effective of the more than 90 statistics used to derive the Quadrix Overall score. So far in 2014, we see more of the same. 

In fact, Value factors occupy the top three spots — and five of the top seven — as measured by the performance of the top one-fifth of S&P 1500 stocks on average monthly returns through October. Value is the most heavily weighted category in the Quadrix Overall score.

TOP QUADRIX SCORES SINCE 2004
Value factors typically dominate Quadrix. But Earnings Estimates factors have also been effective, particularly over the last 10 years. Both have worked well this year. The Overall score, which considers more than 90 factors in six categories, is consistently effective in various markets.
12-Month
Periods
Starting In
Top Category Scores For S&P 1500 Stocks (Average Outperformance Of Top Scorers)
Best
Second Best
Third Best
2013
Value (5.8%)
Overall (2.3%)
Earnings Ests. (0.5%)
2012
Value (5.3%)
Performance (1.3%)
Overall (-0.2%)
2011
Earnings Ests. (0.8%)
Overall (-0.4%)
Quality (-0.4%)
2010
Quality (4.8%)
Earnings Ests. (3.4%)
Overall (2.1%)
2009
Value (11.8%)
Quality (-5.3%)
Overall (-6.3%)
2008
Value (7.1%)
Financial Strength (2.0%)
Quality (1.4%)
2007
Financial Strength (5.9%)
Quality (4.5%)
Earnings Ests. (3.5%)
2006
Momentum (0.5%)
Earnings Ests. (0.2%)
Overall (-0.8%)
2005
Momentum (3.5%)
Earnings Ests. (2.6%)
Performance (1.2%)
2004
Overall (8.3%)
Value (5.7%)
Earnings Ests. (5.0%)

Still, 10 months is too brief a period to say the metrics have enduring qualities. To help identify effective factors with staying power in an ongoing bull market, we also looked for standout metrics using 29 monthly periods since the market turned higher at the end of May 2012.

We gauged effectiveness three ways:

1) We calculated one-month average outperformance of the top one-fifth of S&P 1500 stocks. For example, the cheapest one-fifth based on enterprise value/EBITDA outperformed the average stock in the index by an average of 0.4% since the end of May 2012.

2) Using the same methodology, we also calculated monthly median outperformance.

3) We derived geometric average returns, which take into account the compounding of gains or losses. When returns are choppy, the geometric average return will fall relative to a simple average.

When the dust settled, just eight factors, including two non-Value metrics, ranked among the best:

• Enterprise value/EBITDA ratio.

• Estimated current-year P/E.

• Trailing P/E to three-year median.

• PEG ratio (current-year P/E divided by the expected five-year profit-growth rate).

• Price/cash flow ratio.

• Price/free cash flow ratio.

• Change in the current-quarter profit consensus over the last month.

• Spread of analyst estimates for the next fiscal year around the average estimate. A tighter spread is better.

Listed in the table below are 12 buy-rated stocks with above-average scores in at least six of the eight effective factors. All 12 also earn solid Value and Overall scores — the two most effective Quadrix category scores. Five high-potential stocks are reviewed in the following paragraphs.

Kroger ($58; KR) targets long-term annual growth of 8% to 11% for per-share profits, helped by the steady presence of food inflation and the retailer's recent push into organic foods. Gaining wider acceptance with aspirational and upper-income shoppers, natural and organic food is the fastest-growing grocery segment, with marketwide sales projected to rise 11% to $100 billion this year. Kroger says its organic-food sales are approaching $1 billion a year, or about 1% of company revenue. But as more supermarkets enter the fray, prices have come under pressure, squeezing the niche's above-average profit margins.

Kroger is scheduled to report October-quarter results on Dec. 4. Through late October, Kroger said quarterly same-store sales excluding fuel were growing at a rate similar to the 4.7% posted in the six months ended July. That growth rate exceeds consensus estimates and Kroger's full-year target of 3.5% to 4.25%. Despite management's positive comments, the consensus estimate for per-share profits has held firm at $0.61, implying 15% growth and the potential for an upside surprise. Kroger is a Focus List Buy and a Long-Term Buy.


Magna International ($104; MGA) shares look attractive relative to the S&P 1500 auto-parts industry on multiple fronts. The company earns higher Quadrix scores for Momentum (81), Value (90), Quality (95), and Overall (98) than its peer-group average. The stock has delivered a total return of 27% so far this year, while its peers have averaged a negative return. But at 12 times trailing earnings, Magna trades 36% below the average for its industry. For the 12 months ending September 2015, per-share earnings are expected to grow 10%, matching the industry average; investors can buy Magna's growth for just 11 times estimated year-ahead earnings.

The stock also looks cheap relative to our research universe, scoring in the top quintile in four of the eight valuation metrics presented in the table below. Given the stock's cheap valuation, we are encouraged by management's Nov. 5 announcement that it will repurchase up to 20 million shares over the next 12 months, representing nearly 10% of outstanding shares. Magna is a Focus List Buy and a Long-Term Buy.


The $2.1 billion acquisition of papermaker Boise in October 2013 has boosted Packaging Corp. of America's ($73; PKG) growth, with sales up 81% over the past 12 months. Speculation that PCA will convert all or part of its business into a Master Limited Partnership (MLP) has juiced the stock, up 17% in the past month, versus 9% for the S&P 1500.

PCA says it has begun to explore its options for pursuing an MLP. MLPs enjoy favorable tax treatment — if a company can convince the government to allow the structure. Regulations are complex, but only businesses that generate 90% of cash flows from "qualifying sources" can become MLPs. There is some question whether any of PCA's businesses would qualify. Regardless, the Internal Revenue Service stopped ruling on new MLPs in April to reconsider the criteria, and has not provided a deadline for its review.

The stock looks inexpensive, earning a Value rank of 86. At 16 times trailing earnings, the shares trade at a 14% discount to their three-year median P/E ratio. Just 23% of stocks in the S&P 1500 trade at a steeper discount to their three-year norms. We may consider selling Packaging Corp. if it rallies an additional 10% to 20%. For now, the stock remains a Buy and a Long-Term Buy.


Weak oil prices have taken their toll on U.S. shale drillers and companies that service the industry, such as Schlumberger ($95; SLB). The U.S. rig count dipped to an 11-week low in early November, and some drillers seem cautious about expanding activity for 2015. Compared to some rivals, Schlumberger is geographically well-diversified, with about two-thirds of revenue coming from outside of North America in the first nine months of 2014.

Analyst profit estimates for Schlumberger have eroded over the past three months. The current consensus projects 15% higher per-share earnings for the December quarter (compared to 19% growth 90 days ago) and 13% growth in 2015 (20%).

However, Schlumberger's long-term outlook remains solid. The consensus calls for per-share profits to grow at an average rate of 16% over the next five years. While that seems optimistic, double-digit growth seems achievable if oil prices stabilize around present levels. Schlumberger is a Focus List Buy and a Long-Term Buy.


Already a Long-Term Buy, Travelers ($103; TRV) is being added to the Buy List. For the 12 months ended September, Travelers grew per-share profits 35%, sales 5%, and operating cash flow 22%. September-quarter results benefited from strong investment income and moderate weather that limited catastrophic losses. But claims from non-catastrophic weather jumped, pressuring profit margins. Travelers has pushed through price hikes to bolster profitability.

Travelers funnels much of its excess cash toward stock buybacks, which shrank the share count 9% in the 12 months ended September and 28% since the end of September 2010. The buybacks were opportunistic — management paid an average price of $89 in the past year, and $67 over the past four years.

Shares still look cheap at 10 times trailing earnings, 6% below their five-year average and 31% below the median for S&P 1500 property-and-casualty insurers. In other news, CEO Jay Fishman, age 62, said he has a neuromuscular condition that will affect his ability to walk, though he plans to remain in his role at the company. Travelers is a Buy and a Long-Term Buy.

STOCKS STRONG IN KEY FACTORS
All 12 of the recommended stocks below rank above 50 in at least six of the eight Quadrix factors that have proved most effective this year, and since the market turned to the upside at the end of May 2012. For example, Aetna ($86; AET) earns a 78 in enterprise value/EBITDA, ranking it better than about 78% of stocks in our Quadrix universe.
Quadrix Scores
----------------------------- Ranks For Highly Effective Quadrix Variables -----------------------------
Company (Price; Ticker)
Value
Overall
Enterprise
Value/
EBITDA
Estimated
Current-
Yr. P/E
Trailing
P/E To
3-Year
Median
P/E To
Growth
(PEG)
Ratio
Price/
Cash
Flow
Price/Free
Cash Flow
Dispersion
Of Est.
Next-
Yr. EPS
1-Month
EPS
Revision,
Curr. Qtr.
Aetna ($86; AET)
86
92
78
85
36
72
64
85
54
15
Foot Locker ($56; FL)
69
97
72
71
51
62
54
55
55
60
Kroger ($58; KR)
57
81
70
58
13
52
78
23
79
81
Lear ($95; LEA)
87
96
85
89
37
95
72
55
50
80
Macy's ($62; M)
83
93
78
84
52
77
79
78
25
27
Magna Int'l ($104; MGA)
90
98
81
88
55
86
81
71
34
40
ManpowerGroup
($66; MAN)
95
80
82
85
93
84
64
62
58
10
Micron Technology
($33; MU)
87
100
71
96
NA
92
84
80
16
79
Packaging Corp.
($73; PKG)
86
97
62
69
88
75
77
NA
47
60
Schlumberger ($95; SLB)
77
81
52
59
79
81
59
50
53
19
Southwest Airlines
($39; LUV)
59
98
69
50
52
96
55
52
34
96
Travelers ($103; TRV)
95
99
87
93
86
72
82
84
47
85
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not available.

 


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