Five Screens The Pros Use

10/5/2015


Stock screens are fun.

You identify some criteria that suggest a stock has investment value, rank stocks based on those criteria, and spit out a list of guaranteed winners.

If only it was that easy.

Much of the appeal of stock screens springs from their simplicity. Once you set up the screen, you switch off your brain. Or you could if a single view provided the complete picture. We like screens, too, but only use them in concert with other tools. When you screen for a particular factor such as value or relative strength, you'll end up with a list of stocks that excel in one area but may be marred by huge flaws the screen doesn't consider.

This week we present five cool screens that will unearth stocks with genuine investment appeal. But for each of those screens, we took the concept a little further and built in check-valves — extra criteria that keep the screen from getting carried away.

For example, the screen below focuses on stocks with very high Quadrix Overall scores, a strategy that has historically generated market-beating returns — and avoided stocks with glaring weaknesses. However, we also required exceptional ranks in our sector-specific scores.

The resultant screen, as well as the four others presented below, all start with the same group of companies: U.S.-traded stocks with market values of at least $5 billion.

SCREEN 1: ULTRA-HIGH QUADRIX SCORES
Only 11 companies in our screening universe earn at least 95 in Quadrix Overall, as well as both sector-specific scores, 12-Factor Sector and Reranked Overall. Stocks in green are on our buy lists, those in bold are rated A (above average) on our Monitored List, and most of the others have been considered for purchase in recent months. See pages 4 and 5 for more screens.
---------------------------------------- Quadrix Scores ----------------------------------------
Company
(Price; Ticker)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
12-
Factor
Reranked
Overall
AmTrust Fin'l
($63; AFSI)
48
86
97
60
96
73
97
98
95
D.R. Horton
($29; DHI)
98
55
93
43
91
93
96
98
99
Delta Air
($45; DAL)
89
81
94
64
98
81
99
96
98
Eastman Chem.
($65; EMN)
70
93
74
46
88
46
95
95
99
F5 Networks
($116; FFIV)
88
62
97
95
96
56
97
96
95
Hartford Fin'l
($46; HIG)
96
85
59
52
74
79
96
99
95
Lazard
($43; LAZ)
96
91
96
67
18
39
97
100
98
Lear ($109; LEA)
90
91
90
36
85
63
99
100
100
SunTrust Banks
($38; STI)
84
88
80
97
47
46
95
100
98
Travelers
($100; TRV)
66
90
73
79
85
60
96
98
97
Valero Energy
($60; VLO)
66
93
93
42
61
79
98
87
95
Note: Quadrix scores are percentile ranks, with 100 the best.

True values

Who doesn't like a bargain? Of the six Quadrix category scores that make up our Overall score, Value has worked the best over long periods and commands the largest weighting.

By far the most popular valuation ratio is price/earnings. It's the easiest ratio to find for most companies, and financial writers routinely quote it in news stories. While the price/earnings ratio has its flaws — the ratio doesn't work for companies losing money, and firms can use accounting gimmicks to skew earnings higher — we consider it because stocks with low P/E ratios tend to outperform.

We screened for companies with trailing price/earnings ratios below the average for their sector, their industry, and their own five-year norm. That three-part screen identified 224 stocks with price/earnings ratios that appear low from several angles. However, P/E isn't the only valuation ratio, and plenty of companies that look cheap relative to earnings cast a less-appealing reflection relative to sales, book value, or cash flow. That's where our Quadrix Value score comes in.

The Value score draws on more than 20 valuation metrics, including absolute ratios like price/book and price/sales and relative metrics such as price/sales versus the three- and five-year historical norms. To ensure that stocks passing our low-P/E screen weren't cheap only relative to earnings, we required Value scores above 80, narrowing the field to 106 stocks. The table below features 10 of those stocks, most pulled from our Monitored List.

SCREEN 2: BONA FIDE VALUES
Stocks in green are on our buy lists, stocks in bold are rated A (above average) on our Monitored List, and most of the others have been considered for purchase in recent months.
------ Price/Earnings Ratio ------
Company
(Price; Ticker)
Recent
Vs. 5-
Yr.
Avg.
Vs.
Sector
Avg.
Vs.
Industry
Avg.
Sector
Industry
Quadrix
Value
Score
eBay ($24; EBAY)
8
0.34
0.40
0.29
Technology
Internet svcs.
96
Gilead Sciences
($98; GILD)
9
0.50
0.39
0.33
Health care
Biotechnology
91
Lam Research
($65; LRCX)
13
0.62
0.64
0.66
Technology
Semicond. eq.
84
Lincoln National
($47; LNC)
8
0.89
0.37
0.70
Financials
Life/Health ins.
97
LyondellBasell
($83; LYB)
8
0.82
0.45
0.53
Materials
Chemicals
96
Magna Int'l
($48; MGA)
10
0.87
0.51
0.60
Discretion.
Auto parts
91
MetLife
($47; MET)
8
0.64
0.37
0.70
Financials
Life/health ins.
98
Taiwan Semicond.
($21; TSM)
11
0.71
0.54
0.54
Technology
Semiconductors
86
Valero Energy
($60; VLO)
7
0.67
0.43
0.76
Energy
Oil refining
96
Westlake Chemical ($52; WLK)
9
0.65
0.52
0.61
Materials
Chemicals
95

Catch 'em on the way up

Stocks that rise tend to keep rising.

Even proponents of market efficiency now acknowledge the momentum effect. According to a 2012 study by Eugene Fama and Kenneth French, researchers known for their work on efficient markets and value stocks, stocks with share-price momentum tend to outperform those that lack momentum. According to the Kenneth French Data Library at Dartmouth's Tuck School of Business, the one-fifth of large U.S. stocks with the highest price momentum outperformed those with low momentum in the decade from 2003 through 2012 — and in each of the six previous decades dating back to 1943.

In the table below, we present 10 stocks that over the last six and 12 months have outperformed not only the average stock, but also their sector and industry averages; 192 made the cut after our first screen.

However, the biggest weakness of performance-driven investment strategies involves the forces that drive stock prices. In some cases, stocks jump based on media hype about the company, or in sympathy with competitors that release good news. Plenty of stocks rise for ephemeral reasons, and many of these will wane as fast as they waxed.

To help avoid stocks that rallied based on something other than fundamentals, we eliminated stocks with Quadrix Overall scores below 80, which culled the herd down to 58. In the table below, we present 10 of those stocks.

SCREEN 3: STRONGER THAN THE REST
Stocks in green are on our buy lists and stocks in bold are rated A (above average) on our Monitored List.
--- 6-Month Total Return ---
-- 12-Month Total Return --
Outperformance
----- Versus -----
Outperformance
----- Versus -----
Company (Price; Ticker)
Stock
(%)
Sector
(%)
Industry
(%)
Stock
(%)
Sector
(%)
Industry
(%)
Alaska Air ($79; ALK)
21
33
14
83
83
15
Industrials
C.H. Robinson
($68; CHRW)
(6)
8
8
4
8
9
Industrials
CDW ($41; CDW)
10
17
14
34
28
37
Technology
eBay ($24; EBAY)
4
12
7
14
9
10
Technology
Foot Locker
($72; FL)
15
27
32
29
26
39
Discretion.
Gen. Dynamics
($138; GD)
3
15
21
10
11
20
Industrials
Home Depot
($115; HD)
3
12
23
27
21
33
Discretion.
Lear ($109; LEA)
(1)
7
12
22
15
16
Discretion.
Nvidia ($25; NVDA)
19
24
31
35
27
34
Technology
Starbucks
($57; SBUX)
21
30
22
53
47
32
Discretion.

Going for growth

It's easy to get excited about growth.

Financial markets look forward, and if investors expect a company's profits to remain flat or fall, the stock may have a tough time trading at a high multiple relative to those profits. Thus the appeal of a company that can increase its profits.

Unfortunately, not all growth is created equal.

As we discussed above, the price/earnings ratio values a stock relative to its profits. Assuming the ratio holds roughly constant, higher profits translate into a higher stock price, which puts pressure on companies to deliver growth however they can, including acquisitions, risky investments, and even accounting chicanery.

No investor should buy a stock simply because it puts up big growth numbers. However, starting a screen with growth can identify some exciting options. We screened for companies analysts expect to grow their per-share profits at least 10% in the current fiscal year, next year, and annually over the next five years, yielding 178 names. Then we required Quadrix Earnings Estimates scores above 80 and consensus profit targets that have increased over the last 90 days, which cut the pool to 53 stocks.

However, to eliminate stocks with lots of growth but weak fundamentals, we further required Overall scores above 80. That culled the herd to 29, of which 10 are listed below.

SCREEN 4: EXPECTING A LOT
Each of the 10 stocks below is projected to grow per-share profits at least 10% this year, and next year, and annually over the next five years. We also required rising profit estimates and Quadrix Earnings Estimates and Overall scores above 80. Stocks in green are on our buy lists, stocks in bold are rated A (above aberage) on our Monitored List, and the rest have been new Buy candidates in recent months.
----- Estimated EPS Growth -----
Chg. In Consensus
EPS Estimate
Company (Price; Ticker)
Curr.
Year
(%)
Next
Year
(%)
Next 5
Years
(Annual.)
(%)
Quadrix
Earns.
Ests.
Score
Curr.
Year
(%)
Next
Year
(%)
AutoNation ($58; AN)
18
12
18
96
0.7
1.3
D.R. Horton ($29; DHI)
27
16
22
91
8.3
7.2
Express Scripts
($81; ESRX)
13
10
12
98
1.2
0.8
F5 Networks
($116; FFIV)
21
12
16
96
1.8
1.1
Foot Locker ($72; FL)
18
11
12
99
5.1
5.5
Google
($638; GOOGL)
13
17
17
96
2.9
3.6
Home Depot
($115; HD)
16
15
14
95
0.7
1.4
Lear ($109; LEA)
23
12
14
85
4.3
2.4
Skyworks Solutions
($84; SWKS)
62
17
22
95
2.6
4.9
Walgreens Boots
($83; WBA)
16
20
13
97
4.5
3.0

In search of efficient operators

Logic suggests you'll do better buying companies with good management. Unfortunately, management skill is difficult to measure. One trend we draw on for insight is profitability.

Profit margins reflect the percentage of sales a company collects after meeting expenses. Companies have substantial wiggle room in their reporting. But for the most part gross margin considers profits after the costs of producing goods, while operating margin also takes into account such expenses as salaries, advertising, and marketing.

We also considered another angle on profitability, measuring profits as a percentage of balance-sheet metrics. For this screen, we looked at return on assets (ROA) and return on book value, or equity (ROE).

Rising profitability doesn't always reflect management skill, but it does suggest the business is growing profits faster than revenue, as well as the resources required to generate that revenue. Our profitability screen sought stocks that boosted their operating and gross profit margins, ROA, and ROE over the last 12 months. More than 200 stocks met those criteria.

To weed out slow growers, we required scores above 80 for Quadrix Momentum, which measures operating performance, including short-term increases in sales, profits, and cash flow. This extra layer of screening left us with 73 stocks, of which we present 10 in the table below.

SCREEN 5: STOCKS WITH RISING PROFITABILITY
Each of the 10 stocks below has improved its gross profit margins, return on assets, and return on equity over the last year. Stocks in green are on our buy lists and stocks in bold are rated A (above average) on our Monitored List.
Oper. Profit
---- Margin ----
Gross Profit
---- Margin ----
Return On
---- Assets ----
Return On
----- Equity -----
Company (Price; Ticker)
Last 12
Months
(%)
1 Yr.
Ago
(%)
Last 12
Months
(%)
1 Yr.
Ago
(%)
Last 12
Months
(%)
1 Yr.
Ago
(%)
Last 12
Months
(%)
1 Yr.
Ago
(%)
Alaska Air
($79; ALK)
26.3
21.1
36.0
30.6
11.6
10.5
33.4
32.1
Apple ($110; AAPL)
34.7
33.2
44.2
42.8
20.2
18.2
41.7
31.1
C.H. Robinson
($68; CHRW)
6.3
5.7
16.1
14.8
15.2
14.2
46.0
39.6
Gilead Sciences
($98; GILD)
68.4
59.9
89.9
84.7
43.9
29.9
96.5
60.6
Jones Lang
($144; JLL)
11.4
10.0
11.4
10.0
8.6
6.6
18.3
14.0

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