Four Tips On Using Quadrix

3/23/2015


I designed the Quadrix Overall score to measure all U.S.-traded stocks with a single yardstick, and the metric has performed that task admirably. Since its introduction in 2000, the Overall score has compiled a good record of picking the right sectors and groups — and the right stocks within sectors and groups.

Still, the Overall score's growth-at-a-good-price approach works better in some market segments than in others. That's one reason we created sector-specific scores, which measure stocks relative to sector peers based on metrics that work especially well in a certain sector. But even our sector scores can't account for all the factors likely to drive returns, so we've developed some guidelines on the best way to use our scoring system.

Be wary of wacky data. We've built redundancy and diversity into Quadrix, so it is less likely to be misled by an unusual event, like a huge restructuring charge or one-time gain. But sometimes such items impact several valuation or growth measures, rewarding or penalizing a stock unduly.

Be wary of groups that always trade at rock-bottom valuations. Because reinsurance stocks are nearly always cheap, and because reinsurers have up-and-down growth rates, some stocks in the group nearly always earn very high Overall scores. You may not want to always dismiss such perennially cheap groups, but a high Overall score has not been an effective buying signal in such groups as electronic components, reinsurance, technology distributors, and textiles.

WHAT SECTORS LOOK BEST IN QUADRIX RIGHT NOW
Among the 237 S&P 1500 stocks in the consumer-discretionary sector, the average Overall Quadrix score is 64. About 27% of consumer-discretionary stocks earn Overall scores above 80 — best among the 10 major sectors.
S&P 1500 Sector
(Number Of Companies)
Average
Overall
Score
Average
Value
Score
% With
Overall
Above 80
Number Of
Stocks With
Overall
Above 80
Consumer discretionary (237)
64
56
27
65
Financials (296)
62
58
25
74
Energy (99)
56
74
24
24
Technology (244)
59
51
23
55
Industrials (217)
63
59
22
47
Health care (157)
56
40
16
25
Consumer staples (70)
51
46
14
10
Materials (101)
54
59
12
12
Utilities (60)
56
67
8
5
Telecom services (15)
46
58
7
1
Average of 10 sectors (150)
57
57
18
32

Be wary of cyclical stocks in the late stages of an industry expansion. Cyclical companies tend to have good operating momentum in the late stages of an industry upturn. That is when valuations tend to be modest, since investors are reluctant to pay high price/earnings ratios when earnings may be at a cyclical peak.

We have made money betting on such names; late-cycle stocks are called that because they perform well late in the cycle. But with cyclical stocks we pay extra attention to the likely duration of an industry expansion — and to a company's ability to surpass consensus profit expectations.

Don't be afraid to have a good chunk of your portfolio in a few high-scoring sectors — especially if the sectors are big and Quadrix works well in them. Of the 34 stocks on our buy lists, 22 are from the consumer-discretionary, financial, and technology sectors.

Why so many? First, all three rank among the top four sectors based on the percentage of stocks with Overall scores above 80. Second, all three sectors include a lot of stocks, with a wide variety of industry groups. Third, Quadrix tends to work well in all three sectors. Based on the frequency with which top-ranked stocks deliver top-quintile year-ahead returns, consumer discretionary and technology rank among the top four sectors. Based on the frequency with which top-ranked stocks deliver above-average returns, financials rank No. 1.

QUADRIX ACCURACY BY SECTOR
For 229 month-ends beginning at year-end 1994, S&P 1500 energy stocks earned scores above 80 for Overall Quadrix 6,101 times. In 26.8% of those 6,101 cases, the stock went on to deliver year-ahead returns among the top one-fifth of S&P 1500 stocks. In 54.8% of those 6,101 cases, the stock went on to deliver returns among the top one-half of S&P 1500 stocks.
Number Of
Times Stocks
In Sector
Had Overall
Scores
Above 80
Frequency With With Stocks In Sector
With Overall Scores Above 80 Ranked Among
-------- Year-Ahead Return Leaders --------
S&P 1500 Sector
Top
Quintile
(%)
Rank
Top Half
(%)
Rank
Energy
6,101
26.8
1
54.8
3
Consumer discretionary
15,424
25.7
2
52.9
6
Health care
7,565
25.2
3
53.7
4
Technology
10,965
23.5
4
48.3
10
Materials
3,762
23.3
5
52.0
8
Consumer staples
2,226
22.9
6
52.6
7
Financials
11,447
20.7
7
58.2
1
Industrials
11,473
20.1
8
53.0
5
Utilities
1,200
19.8
9
54.9
2
Telecom services
438
18.5
10
48.6
9

Conclusion

Diversification is the one free lunch on Wall Street, and you never want a single sector to dominate your portfolio. But don't let your desire for diversity lead you into second-tier names, and don't focus excessively on sector labels. Our buy lists have delivered market-beating returns with below-average risk since 2000, even though we have often overweighted a few sectors.

For now, we are holding about 85% of our buy lists in stocks as we watch the averages. A close in the Dow Transports above 9,217.44 would reconfirm the bullish primary trend. Without new highs in the Transports, breakdowns below 17,164.95 in the Dow Industrials and 8,649.32 in the Transports would be a bear-market signal. Six top picks for new buying are listed in the table below.

What works in three key sectors: Average outperformance of top quintile
Based on Quadrix Overall scores, consumer discretionary, financial, and technology rank among the best sectors. For stocks in all three sectors, a score above 80 has meant an increased probability of good year-ahead returns since 1994. Also, as shown below, Quadrix Overall scores and our sector scores do a good job of identifying the best year-ahead performers in all three sectors. For example, the top one-fifth of S&P 1500 consumer-discretionary stocks on Overall score has outperformed the entire sector by an average of 3.3% per year since 1994.
-------------------------------------------- Quadrix Scores --------------------------------------------
------ Sector Scores ------
S&P 1500 Sector
Overall
(%)
Momen-
tum
(%)
Value
(%)
Quality
(%)
Financial
Strength
(%)
Earnings
Estimates
(%)
Perfor-
mance
(%)
12-Factor
Sector
(%)
Reranked
Overall
(%)
Consumer discretionary
3.3
1.8
2.0
0.8
(1.3)
(0.4)
0.7
5.8
4.0
Financials
2.1
1.0
4.7
1.3
(0.2)
0.0
(0.6)
3.9
4.4
Technology
3.0
(0.5)
1.6
2.1
1.0
(0.9)
(0.4)
6.1
2.5
Average of 10 sectors
1.1
0.3
3.3
(0.1)
(1.4)
0.2
(0.4)
4.6
3.1
Our favorite stocks in consumer-discretionary, financial, and tech sectors
------------------------------ Quadrix Scores -----------------------------
-- Sector Scores --
Company (Price; Ticker)
Overall
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
12-
Factor
Sector
Reranked
Overall
Sector
Industry
Lear ($111; LEA)
99
90
88
92
35
67
74
100
99
Discretionary
Auto Parts
Foot Locker ($61; FL)
92
68
65
93
41
86
77
62
92
Discretionary
Apparel Retail
Ameriprise
($135; AMP)
98
94
79
88
62
88
56
94
97
Financials
Asset Mgmt. 
Jones Lang LaSalle
($164; JLL)
97
95
63
95
52
90
81
96
91
Financials
REIT Svcs.
Apple ($128; AAPL)
99
94
69
98
91
96
88
94
100
Technology
Hardware
Nvidia ($23; NVDA)
97
96
57
87
69
97
90
59
98
Technology
Semiconduct.

 


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