With Growth Scarce, Resist Overpaying For It

7/27/2015


I've found I do best when I approach the stock market systematically, focusing relentlessly on two questions:

• Where can I find attractively valued growers?

• Can I find enough of them to build a diversified portfolio?

For both questions I start with Quadrix, which compares U.S.-traded stocks on nearly 100 variables in six categories. Everything is relative in Quadrix, so 50% of stocks will always receive scores above 50. But the growth rates and valuation levels required to get a 50 go up and down, providing perspective on how today's opportunity set compares to those of the past 25 years.

Because I am always searching for Quadrix standouts to recommend in Dow Theory Forecasts and Upside, I'm also always looking for ways Quadrix can steer me wrong. I've learned to be wary of cyclicals enjoying a late-cycle growth spurt, of management teams too reliant on acquisitions, and of natural-resource companies benefiting from higher prices.

Today, I'm wary of middling growers being treated like stalwarts because growth is in short supply. Among members of the broad S&P 1500 Index, the median company delivered year-to-year sales growth of 3.6% in its most recent quarterly report, well below the norm of 6.1% since 1994 — and lower than about 79% of month-ends since 1994. The median company had 5.6% growth in per-share earnings, below the norm of 9% and lower than about 86% of month-ends.

In such a growth-starved environment, it's easy to justify paying up for reliable growers. To some extent, my willingness to stick with CVS Health ($111; CVS), Google ($695; GOOGL), and Kroger ($39; KR) despite below-average Quadrix Value scores reflects this line of thinking. But history suggests paying a truly premium valuation to be in the very fastest growers is usually a mistake. That's worth keeping in mind before you buy a fund with heavy exposure to the high-flying biotech or internet-commerce groups.

A better bet, in my view, is a basket of solid but mostly unremarkable growers that — for one reason or another — sell at a discount. As shown below, the average stock on our Buy List trades at 16 times expected current-year earnings, versus 21 times for the average stock in the S&P 1500.

OUR PICKS: GROWTH AT A DISCOUNT
----- Current Fiscal Year -----
------- Next Fiscal Year -------
---- % Chg. ----
---- % Chg. ----
Company (Price; Ticker)
Fiscal
Year
End
Est.
EPS
($)
EPS
(%)
Sales
(%)
Est.
P/E
Est.
EPS
($)
EPS
(%)
Sales
(%)
Est.
P/E
Affiliated Mgrs.
($219; AMG)
Dec-15
13.61
18.9
7.7
16
15.39
13.1
12.1
14
Alaska Air ($76; ALK)
Dec-15
6.16
47.3
5.2
12
6.38
3.7
6.0
12
Ameriprise Fin'l
($127; AMP)
Dec-15
9.37
10.0
1.3
14
10.93
16.6
6.4
12
Apple ($125; AAPL)
Sep-15
9.08
40.8
26.7
14
9.79
7.8
4.4
13
CBRE ($38; CBG)
Dec-15
1.98
18.0
10.7
19
2.30
16.1
22.7
17
CDW ($34; CDW)
Dec-15
2.73
15.3
5.3
13
3.01
10.3
6.3
11
Comcast ($65; CMCSa)
Dec-15
3.32
13.2
5.6
19
3.75
13.1
5.7
17
Community Health
($59; CYH)
Dec-15
4.00
21.7
7.4
15
4.53
13.1
4.6
13
Corning ($19; GLW)
Dec-15
1.50
(2.2)
5.5
13
1.61
7.8
2.8
12
CVS Health
($111; CVS)
Dec-15
5.17
15.0
8.0
22
5.93
14.8
8.2
19
Disney ($119; DIS)
Sep-15
5.04
16.7
7.7
24
5.71
13.2
7.1
21
F5 Networks
($119; FFIV)
Sep-15
6.44
18.6
11.0
18
7.23
12.4
10.6
16
Foot Locker ($70; FL)
Jan-15
4.00
11.8
2.6
18
4.44
11.0
6.0
16
Gilead Sciences
($117; GILD)
Dec-15
10.84
33.9
19.3
11
11.15
2.9
0.5
11
Goodyear Tire
($30; GT)
Dec-15
2.98
6.3
(9.0)
10
3.56
19.2
2.1
9
Google ($695; GOOGL)
Dec-15
28.89
12.9
12.5
24
33.47
15.8
15.1
21
HCA Holdings
($93; HCA)
Dec-15
5.27
12.2
6.8
18
5.78
9.6
5.3
16
J.P. Morgan Chase
($70; JPM)
Dec-15
5.84
10.4
(0.6)
12
6.47
10.8
5.2
11
Jones Lang LaSalle
($174; JLL)
Dec-15
9.48
9.1
8.8
18
10.21
7.8
7.6
17
Kroger ($39; KR)
Jan-15
1.94
10.5
2.2
20
2.14
10.2
5.6
18
Lam Research
($76; LRCX)
Jun-15
5.02
13.7
25.6
15
5.83
16.1
5.3
13
Lear ($99; LEA)
Dec-15
9.60
17.8
4.3
10
10.97
14.3
4.9
9
Lincoln National
($59; LNC)
Dec-15
6.05
0.3
(0.4)
10
6.67
10.3
3.8
9
Macy's ($72; M)
Jan-15
4.70
6.7
0.7
15
5.15
9.6
1.8
14
Magna Int'l
($54; MGA)
Dec-15
4.65
1.6
(10.4)
12
5.59
20.1
6.7
10
Mylan ($68; MYL)
Dec-15
4.12
15.6
26.1
17
4.66
13.1
6.8
15
Nvidia ($19; NVDA)
Jan-15
0.76
(32.1)
(4.2)
26
1.07
40.8
7.2
18
Shire ($259; SHPG)
Dec-15
11.41
7.7
6.0
23
13.26
16.3
12.5
20
Skyworks Sol.
($100; SWKS)
Sep-15
5.12
58.1
40.8
20
5.94
15.9
11.7
17
Southwest Airlines
($35; LUV)
Dec-15
3.34
65.9
4.6
11
3.36
0.6
6.0
11
U.S. Bancorp
($46; USB)
Dec-15
3.23
5.2
0.4
14
3.52
9.0
5.7
13
Wells Fargo
($59; WFC)
Dec-15
4.14
1.1
2.8
14
4.52
9.1
6.0
13
Average for Focus List stocks
18.4
8.7
16
11.3
6.7
14
Average for
Buy List stocks
18.9
10.1
16
12.4
7.8
15
Average for Long-
Term Buy List stocks
15.7
7.5
16
12.6
7.0
14
Average for
S&P 500 stocks
6.0
2.6
20
12.9
6.5
18
Average for
S&P 1500 stocks
7.8
4.5
21
15.4
6.9
19

Yet the average Buy-rated company is expected to report per-share-earnings growth of nearly 19% this year and more than 12% next year, versus respective averages of 8% and 15% for S&P 1500 companies. For sales, Buy-rated companies are expected to average growth of 10% this year and nearly 8% next year, above the respective S&P 1500 averages of 4.5% and 7%.

Why are solid growers available at discount valuations? I have two answers. First, looking for attractively valued growers is what Quadrix does best, and such stocks are often underappreciated. Diehard growth investors are not going to get very excited about a company reporting 5% to 10% sales growth, and a fairly reliable 5% to 10% grower is seldom cheap enough for a dyed-in-the-wool value investor.

Second, many of our recommendations face skepticism regarding their recent operating momentum. For example, Alaska Air ($76; ALK) and Southwest Airlines ($35; LUV) are expected to see growth slow sharply next year because of tougher comparisons and more competitive pricing. Foot Locker's ($70; FL) valuation reflects worries about its vulnerability to online shopping.

Making a huge bet on Foot Locker because you think Wall Street is exaggerating the internet threat is risky. But including Foot Locker as part of a diversified portfolio is a good move, especially if your other holdings are not premised on this same bet. In other words, adding another mall-based retailer to your portfolio may not be worth the added risk if you already own several.

What to do now

Profit growth should improve in 2016 as comparisons get easier and currency becomes less of a headwind. Attractively valued growers are available, but tough to find in some sectors. Our Buy and Long-Term Buy lists have relatively heavy exposure to the technology, financial, and consumer-discretionary sectors, mostly because a lot of stocks in those groups are attractively valued growers with good Quadrix Overall scores.

While our Buy and Long-Term Buy lists are not fully diversified portfolios, they provide enough diversification for subscribers to mimic with the bulk of their portfolios. If you want to add our picks to an existing portfolio, consider mimicking our Focus List.

Also, keep the primary trend in mind when you assess the outlook for corporate earnings and the stock market. When the majority money opinion is bearish, as evidenced by both the Dow Industrials and Dow Transports hitting significant lows, be prepared for profit disappointments and shrinking P/Es.

For now, with the last signal under the Dow Theory bullish, our buy lists have 78.8% to 80.2% in stocks. If the Industrials close below 17,164.95, we will lower our exposure.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com