The Weather Patterns Of Quadrix

7/27/2015


Because our Quadrix system relies on nearly 100 statistics, the scores are constantly changing. Stats such as sales and earnings growth update quarterly, often with substantial changes from quarter to quarter. Other metrics that change quarterly, like the ratio of long-term debt to capital, tend to shift more gradually. Still other statistics, such as valuation ratios, total returns, or earnings-estimate trends, can change quite a bit from week to week.

Those changes provide Quadrix with its dynamism, its power. But they also cause scores to fluctuate in ways that might spook investors. In fact, some readers have complained to us about scores changing suddenly, wondering whether they should trust the numbers. This story was written to make two points:

1) The volatility of Quadrix scores has a pattern, one we can explain.

2) You can trust Quadrix to work despite — and in some ways because of — that volatility.

Seasons of change

In the last 21 Junes, the average stock in the S&P 1500 Index saw its Quadrix Overall score move (either rise or fall) 4.0 points. However, the average change in July was 6.4 points. Reflected another way, scores rose or fell an average of 16% in July, versus just 9% in June.

This disparity repeats at regular intervals, with Overall scores most volatile in January, April, July, and October — months when a lot of companies with a March-June-September-December quarterly schedule declare profits. Given the preponderance of statistics that update quarterly — particularly the growth metrics used for Momentum and Quality scores — such seasonality shouldn't surprise us.

The chart above probably underplays the seasonality for at least two reasons:

• More than 12% of S&P 1500 Index companies operate on a different quarterly schedule and declare earnings in months other than April, July, October, and January.

• A lot of companies with March quarters — particularly the smaller ones — declare earnings more than a month after the quarter ends.

Even with both groups of companies mentioned above throwing off the schedule, the seasonality of Overall scores is clear.

Also clear is the next obvious question. "What should investors do about that seasonal volatility?"

The short answer is, "Nothing you wouldn't normally do." The scores themselves tell the story. If a stock's score jumps, it generally means something has changed for the better. And if the score drops, dig deeper to find out what's wrong.

This advice will affect a lot of stocks. On average, in January, April, July, and October, more than 20% of S&P 1500 stocks see their Overall scores rise or fall more than 10 points. In the remaining eight months, only 13% of scores change that much.

Quadrix's winning percentage — the likelihood that top Overall scorers outperform the average stock in the index — is fairly steady from month to month.

Bottom line

While Quadrix scores may exhibit seasonal shifts, the stock-rating system itself has all-weather appeal. Given Quadrix's statistical underpinnings, big moves in Overall scores are supposed to happen, and are necessary to adjust a stock's rank relative to the rest of our 5,000-stock universe.

You should already be following your stocks' Quadrix score, and this week's research suggests you should pay even closer attention around earnings time. Track your favorite stocks using our Portfolio Manager (www.DowTheory.com/Go/Port), which allows you to access the latest Quadrix scores with a single click.

While Quadrix-score fluctuations aren't unusual, our research suggests stocks that consistently earn high Overall scores tend to outperform. Here are eight recommended stocks that have earned Overall scores of at least 80 in 23 of the last 24 months. For a more comprehensive list, visit www.DowTheory.com/Go/Consistent.

• F5 Networks ($119; FFIV).
• Foot Locker ($70; FL).
• Kroger ($39; KR).
• Lear ($99; LEA).
• Magna International ($54; MGA).
• Shire ($259; SHPG).
• Skyworks Solutions ($100; SWKS).
• Southwest Airlines ($35; LUV).


Flavors of seasonality

Seasonal categories

Among our six Quadrix category scores, Momentum shows the strongest, clearest seasonality. These scores rely primarily on growth numbers updated quarterly, so sharp seasonality makes sense. March, June, September, and December show minimal changes; these months feature by far the smallest number of companies declaring earnings.

Most valuation ratios feature a denominator that changes quarterly, such as earnings or cash flow, while the price in the numerator could vary every time we do our weekly recalculations. Earnings Estimates and Performance scores don't use quarterly data at all, but companies tend to update their guidance along with quarterly results — and investors often react to those results and guidance, driving stocks up or down.

Changes in Value, Earnings Estimates, and Performance scores tend to be strongest in January, April, July, and October. However, the variance is relatively small and far from absolute. Call it weak seasonality.

Quality and Financial Strength scores are tougher to parse. We see seasonality in the last three quarters of the year, but both scores are most volatile in the first quarter.

The first-quarter disparity might stem from the fact that some of the statistics used for these scores — particularly Financial Strength — depend on numbers like debt and interest, which management can often affect simply by altering capital plans. Many companies revisit such policies at the end of the fiscal year.


The anomaly

A few months ago, an alert reader noticed that Foot Locker's ($70; FL) Financial Strength score fell to 40 in March from 68 in February. The Financial Strength score is among the least-volatile Quadrix scores, so we wondered what was up. Turns out the dip was a pattern that repeated.

In months the company declared earnings, three statistics came up NA, or not available. We see NAs frequently, as some companies simply don't report all the data we need to calculate a given metric. Most companies are missing at least one statistic in any given month. However, the next month Foot Locker's scores came in just fine, and it just so happened that those stats are Foot Locker's strength — it consistently ranks above 80 in all three, driving up the Financial Strength score.

Foot Locker, like many companies, releases data from the income statement with its earnings release but doesn't present everything from the balance sheet and cash-flow statement until the 10-Q statement is filed. So when our data provider started to fill in the most recent quarter, some key numbers were unavailable. Of course, by the end of the next month the SEC data had filtered into the system, and the problem corrected itself.

If you run into such an anomaly, a big decline in one of the category scores despite an apparently solid quarter and strong Overall scores, don't panic. Assuming all else is OK, wait a couple weeks and give the company's financial disclosure a chance to catch up.

Quadrix Scores
Date
Overall
Financial
Strength
06/30/15
95
73
05/29/15
96
47
04/30/15
92
69
03/31/15
93
40
02/27/15
87
68
01/30/15
94
67
12/31/14
97
67
11/28/14
97
39
10/30/14
97
69
09/30/14
98
68
08/29/14
97
41
07/31/14
96
72

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