Go For Growth

12/22/2014


While you should always be looking for bargains, you shouldn't confine your search to the cheapest stocks with the worst growth rates. That is especially true today, as valuations versus historical norms suggest investors may be undervaluing expected profit growth.

If you divide S&P 1500 Index stocks into five quintiles based on the consensus estimate for long-term expected profit growth, the quintile of the fastest growers is the only one trading at a discount to 20-year norms based on average trailing price/earnings ratio. This quintile has by far the highest P/E, as shown in the table below. But it is by far the most attractive versus its 20-year norm for P/E or Quadrix Value score.

THE PRICE OF GROWTH AND PREDICTABILITY

For the upper table shown below, we divided S&P 1500 stocks into five quintiles based on long-term expected growth, repeating this process for every month-end since December 1994. As shown, the best quintile, with the fastest expected growers, has a median trailing P/E ratio of 25.8. That is 96% of the 20-year norm — and higher than 42% of month-ends since 1994.

For the bottom table, we divided S&P 1500 stocks into quintiles based on earnings predictability. Our earnings-predictability score reflects the consistency of year-to-year earnings growth, assigning the highest scores to companies with the least volatile earnings growth.

S&P 1500 Stocks Divided Into Quintiles
------------------- Based On Long-Term Expected Profit Growth -------------------
------------ Median P/E Ratio ------------
-- Median Quadrix Value Score --
Best
2Q
3Q
4Q
Worst
Best
2Q
3Q
4Q
Worst
Recent median
25.8
21.9
20.8
17.6
17.9
48
53
57
61
59
Norm since 12/94
26.9
20.6
17.9
16.5
15.1
40
52
60
64
68
Recent as
% of norm
96
107
116
107
118
120
100
95
96
87
% of month-ends
lower since 12/94 
42
69
90
69
97
97
48
28
31
17
   
S&P 1500 Stocks Divided Into Quintiles
--------------------------- Based On Earnings Predictability ---------------------------
------------ Median P/E Ratio ------------
-- Median Quadrix Value Score --
Best
2Q
3Q
4Q
Worst
Best
2Q
3Q
4Q
Worst
Recent median
21.5
18.3
20.4
19.8
23.1
48
63
56
58
52
Norm since 12/94
18.2
17.2
17.8
18.5
19.4
56
59
58
58
57
Recent as
% of norm
118
106
115
107
119
85
106
96
99
91
% of month-ends
lower since 12/94 
96
69
88
70
90
5
78
26
45
8

The Value score reflects percentile ranks for about 20 valuation measures, including such ratios as P/E, forward P/E, price/cash flow, and enterprise ratio. To a lesser extent, the Value score also reflects how those ratios compare to three- and five-year norms. The cheapest stocks earn the maximum Value score of 100.

The quintile with the fastest growers earns an average Value score of 48, above the 20-year norm of 40 and higher than 97% of month-ends since 1994. The slowest growers earn a Value score of 59, below the norm of 68 and higher than only 17% of month-ends. While these comparisons do not mean the fastest-growing quintile will outperform, they do imply this is a good time to be looking for buying opportunities among bona fide growers — and selling opportunities among richly valued sluggards.

Just as valuation comparisons suggest investors may be underpaying for expected growth, they imply investors may be overpaying for earnings predictability. Our earnings-predictability score is based on the consistency of year-to-year earnings growth over the prior 20 quarters, with steady growers getting the highest scores. The top quintile for earnings predictability has an average Value score of 48, below the norm of 56 and higher than only 5% of month-ends since 1994. Today, the most attractively valued stocks, based on both absolute and relative valuations, are those with middling earnings predictability.

Our advice

Looking for a way to capitalize on these trends? Here are two:

• Consider buying the 12 stocks listed in the top portion of the table below. All 12 rank higher than more than two-thirds of U.S. stocks based on expected long-term profit growth. For all 12, PEG ratios (current-year P/E divided by the annual rate of expected long-term profit growth) are lower than at least three-fourths of U.S. stocks. All 12 earn Overall Quadrix scores above 80, with all but one earning Value scores above 50.

• Consider selling the seven stocks listed in the bottom portion of the table. All seven earn highs scores for earnings predictability, but their expected long-term growth rates are lower than at least 75% of U.S. stocks. For all seven, PEG ratios are among the most expensive 26% of U.S. stocks. All seven, with below-average scores for Overall and Value, are rated C (below-average) after this week's downgrades of Altria ($50; MO) and PepsiCo ($94; PEP).

GROWERS LOOK BETTER THAN SLUGGARDS
Listed below are 12 recommended stocks with superior expected growth rates, along with seven slow growers with expensive valuations. For example, Alaska Air's long-term expected profit growth rate of 24.6% is higher than about 87% of U.S. stocks, while Altria's rate of 8.0% is lower than all but about 22% of U.S. stocks. Quadrix scores are percentile ranks, with 100 the best.
Quadrix
---- Scores ----
P/E On
Curr.-Yr.
-- EPS Est. --
PEG (P/E
To Expected
Growth)
Earnings
Predict.
% Rank
Long-Term
Expected
Profit Growth
Company (Price; Ticker)
Overall
Value
Ratio
%
Rank
Ratio
%
Rank
Rate
%
Rank
12 GROWERS TO CONSIDER BUYING . . .
Alaska Air ($56; ALK)
99
74
14
79
0.55
95
61
24.6
87
Ameriprise ($129; AMP)
93
65
15
65
0.94
83
88
16.8
69
Cognizant ($51; CTSH)
96
58
20
44
1.11
76
100
18.1
74
Gilead Sciences ($102; GILD)
98
65
13
80
0.45
96
77
29.6
92
Halliburton ($39; HAL)
86
98
10
93
0.46
96
81
20.7
82
Lam Research
($78; LRCX)
96
62
17
59
0.99
81
83
17.0
70
Lear ($93; LEA)
95
84
12
87
0.58
94
78
20.1
81
SanDisk ($99; SNDK)
81
55
17
57
0.75
91
52
23.4
86
Schlumberger ($83; SLB)
83
87
15
71
0.88
86
93
17.0
70
Skyworks ($71; SWKS)
96
41
15
68
0.78
90
95
19.8
77
Southwest Air.
($40; LUV)
97
53
21
38
0.51
95
91
41.3
96
United Rentals
($99; URI)
94
66
16
63
0.93
84
49
17.5
72
. . . AND 7 SLUGGARDS TO CONSIDER SELLING
Altria ($50; MO)
43
25
19
46
2.44
26
94
8.0
22
Coca-Cola ($42; KO)
33
39
20
42
3.85
14
88
5.3
13
Colgate-Palmolive
($69; CL)
28
27
23
30
2.78
21
98
8.4
25
Kimberly-Clark
($114; KMB)
42
45
20
45
2.91
20
90
6.8
18
PepsiCo ($94; PEP)
43
40
21
39
2.78
21
84
7.5
20
Procter & Gamble
($91; PG)
38
36
21
40
2.66
23
89
7.8
21
Stryker ($93; SYK)
35
32
20
45
2.44
26
95
8.0
23

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