Seeking Sell Signals

11/30/2015


Investors tend to spend most of our time trying to answer two key questions:

1) What stocks should I buy?

2) When should I sell the stocks I own?

We at the Forecasts have a pretty good answer for the first question. Our Quadrix stock-rating system identifies stocks with superior total-return potential, a task it performs with admirable success. (See www.DowTheory.com/Go/Perform to learn how well we've done selecting stocks with Quadrix.) But getting into the right stocks is only half of the job.

Choosing when to sell can require even more objectivity than the decision to purchase a stock. Our Quadrix system doesn't work as well on the downside as the upside, in part because, like most quantitative systems, it looks backward more than forward. Many times, we choose to sell stocks because of events we believe will affect operating results going forward but have yet to show up in the statistics Quadrix uses.

Quadrix was never designed to serve as a sell signal on its own. But it can provide some clues.

In an effort to find those clues, we divided the S&P 1500 Index into fifths based on total returns over the next 12 months, then assessed the characteristics of those stocks before that year. Not surprisingly, stocks about to deliver the weakest performance tended to earn lower Quadrix Overall and category scores, as shown below.

LOWER SCORES, LOWER RETURNS
On average, stocks in the S&P 1500 index with weaker 12-month returns tended to earn lower Quadrix Overall and category scores before that return period. The spreads aren't large, but the differences in scores are apparent, particuarly for stocks among the lowest one-fifth in returns. The disparity in score between the weakest performers and the rest of the pack was largest with the Overall, Value, and Earnings Estimates scores.
Average Quadrix Score For Quintiles
---------- Based On Average Return For Next 12 Months ----------
Worst Returns ------------------------------------------- Best Returns
Overall
54
59
60
60
58
Momentum
50
51
51
51
52
Value
52
57
59
59
58
Quality
57
60
60
60
58
Financial Strength
55
59
60
59
56
Earnings Estimates
47
51
51
51
51
Performance
49
52
52
52
50
Note: Quadrix scores are percentile ranks, with 100 the best.

At first blush, you might expect a larger spread between the scores for the best and worst returners. But the fairly tight spread doesn't surprise us, as even stocks in the least-promising quintile often score well in a few categories. On average, stocks in the quintile about to post the highest returns average Overall scores of 58, versus 54 for the weakest quintile.

The score differential in Value is even greater, 58 to 52. The stronger performers average Earnings Estimates scores of 51, versus 47 for the weaker ones, and the other four category scores have rank differentials of less than two.

Category scores for the weakest performers were not, on average, low enough to be danger signs on their own, though they support our longtime contention that higher-scoring stocks tend to outperform. When we drilled down to individual factors, the focus tightened. A little.

We consider roughly 100 variables for our Quadrix ranks, of which 77 have at least 10 years of data. For only four of those did we see the quintile with the weakest returns average scores at least three points below the average for top performers — enterprise ratio, price/current-year estimated earnings, price/current-year estimated earnings divided by the three-year median P/E, and the spread between low and high profit estimates for the next fiscal year.

This research suggests stocks with low scores in the four key statistics may be at a greater risk of underperforming. Does this trend equate to a sell signal? Not quite. Call it a yellow flag.

Listed in the table below are some large, well-known companies with poor scores. We also present A-rated stocks with solid scores in the four statistics, as well as Value and Overall; three of those companies are reviewed below, with a fourth profiled on page 8.

Alaska Air Group ($80; ALK) earns Quadrix scores of 80 or higher for enterprise ratio and forward P/E ratio, as well as a Value score of 79. The shares aren't particularly cheap relative to the typical airline. However, analysts expect long-term profit expansion of at least 15% a year, and with Alaska trading at 13 times trailing earnings, that growth isn't too expensive.

Despite aggressive expansion, Alaska's operating profit margin reached 28.4% in the 12 months ended September, up from 21.5% in same period a year earlier and 17.6% two years ago. Low fuel prices deserve much of the credit for that rise in profitability, a trend that won't last forever. However, demand for air travel remains strong, and while margins could compress in coming quarters if fuel prices rise, analysts expect sales to increase 6% next year. Alaska Air is a Focus List Buy and a Long-Term Buy.


The biotechnology industry has long been equated with high growth and high valuations. Gilead Sciences ($107; GILD) has delivered the growth (sales up 52% and per-share profits up 94% over the last year), but stands out from the crowd because of its value. Gilead earns a Value score of 93, second-highest among S&P 1500 Index biotech companies and more than double the industry average score of 36. The company averages a score of 87 in the three featured Value metrics.

The consensus projects 2% declines in both sales and profits in 2016 with a wide spread of estimates, suggesting differences of opinion between analysts covering the company. While hepatitis C drugs won't match the torrid growth they've enjoyed over the last year, we see the 2016 targets as unduly low. Gilead says it has treated less than 10% of the hepatitis C patients in the U.S. and five large European countries, and a new markets are still opening up overseas. Gilead is a Focus List Buy and a Long-Term Buy.


J.P. Morgan Chase ($67; JPM) trades at 11 times expected 2016 earnings, 23% below the average diversified bank in the S&P 1500. While such a discount may have been justified a couple years ago, the financial giant's star is on the rise. After paying tens of billions of dollars in fines, J.P. Morgan seems to have left its thorniest legal woes behind. The per-share dividend has jumped ninefold over the last five years and today equates to a 2.6% yield.

Per-share profits rose 13% annualized over the last three years, and despite weakness in the trading business in the September quarter, J.P. Morgan seems capable of topping analyst targets for 2016, which call for growth of 5% in sales and profits. The company has topped the consensus in each of the last three quarters, including a 23% surprise in the September quarter. J.P. Morgan is a Buy and a Long-Term Buy.

STOCKS TO AVOID — AND SOME TO CONSIDER
We identified four Quadrix statistics in which weak-performing stocks tend to score poorly. Below are 28 large-cap stocks that score below 40 in at least three of the stats. In contrast, we've listed 15 A-rated stocks that score above 60 in at least three of the four stats. Stocks in bold are recommended for purchase.
   
----------- Four Key Quadrix Ranks -----------
         
---------- Value Factors ----------
Earns. Ests.
Factor
Quadrix Scores
Company (Price; Ticker)
Stock-
Market
Value
($Bil.)
Enterprise
Ratio
Price/
Curr.-Yr.
Estimated
Earnings
Price/
Curr.-Yr,
Estimated
Earnings
Vs. 5-Yr.
Median
Estimate
Spread,
Next
Year
Average
Of 4
Key
Ranks
Number
Below 40
Number
Above 60
Value
Overall
Sector
Big-name stocks with small-time Quadrix scores
Activision Blizzard
($37; ATVI)
27.2
30
22
7
27
22
4
0
24
80
Technology
Altera ($53; ALTR)
16.1
5
8
2
23
10
4
0
8
17
Technology
American Tower
($99; AMT)
42.4
11
6
16
30
16
4
0
19
41
Financials
Baker Hughes
($53; BHI)
23.3
64
0
0
0
16
3
1
35
17
Energy
Bristol-Myers Squibb
($68; BMY)
113.8
5
14
12
38
17
4
0
9
29
Health care
C.R. Bard
($186; BCR)
13.8
29
30
38
78
44
3
1
29
34
Health care
Coca-Cola ($43; KO)
190.7
17
36
33
62
37
3
1
27
30
Cons. staples
Colgate Palmolive
($67; CL)
60.6
25
29
35
70
40
3
1
27
30
Cons. staples
ConAgra Foods
($42; CAG)
18.1
37
42
27
37
36
3
0
36
23
Cons. staples
ConocoPhillips
($55; COP)
68.7
47
0
0
3
13
3
0
31
9
Energy
Dollar Tree
($74; DLTR)
15.9
17
29
18
41
26
3
0
34
33
Cons.
discretion.
DuPont ($67; DD)
60.1
29
28
12
49
30
3
0
27
25
Materials
EOG Resources
($85; EOG)
46.5
46
0
0
2
12
3
0
24
21
Energy
Equinix ($293; EQIX)
16.9
13
5
40
38
24
3
0
11
26
Financials
Expedia ($121; EXPE)
16.2
13
18
25
26
21
4
0
31
56
Cons.
discretion.
General Electric
($31; GE)
311.9
15
30
11
41
24
3
0
24
25
Industrials
Kinder Morgan
($24; KMI)
56.2
23
14
52
27
29
3
0
36
13
Energy
Molson Coors
Brewing ($92; TAP)
17.1
6
27
4
71
27
3
1
12
18
Cons.
staples
Motorola Solutions
($72; MSI)
14.5
30
33
35
31
32
4
0
24
37
Technology
Noble Energy
($37; NBL)
15.5
9
0
0
1
3
4
0
23
13
Energy
PepsiCo ($101; PEP)
149.2
29
33
24
69
39
3
1
31
38
Cons.
staples
SanDisk ($74; SNDK)
15.3
35
30
14
16
24
4
0
35
29
Technology
Sigma-Aldrich
($140; SIAL)
16.9
13
16
7
68
26
3
1
13
32
Materials
Spectra Energy
($27; SE)
18.3
36
30
37
31
34
4
0
51
34
Energy
Sysco ($41; SYY)
24.8
38
36
38
56
42
3
0
37
28
Cons.
staples
Weyerhaeuser
($32; WY)
16.6
26
17
19
34
24
4
0
32
29
Financials
Xilinx ($49; XLNX)
13.1
24
28
19
35
27
4
0
30
48
Technology
Yahoo ($33; YHOO)
31.2
4
7
2
8
5
4
0
11
6
Technology
A-rated stocks with strong scores
Aetna ($106; AET)
37.4
71
72
19
71
58
1
3
69
75
Health care
Alaska Air ($80; ALK)
10.2
82
80
63
42
67
0
3
79
99
Industrials
American Express
($72; AXP)
71.4
49
75
66
66
64
0
3
85
71
Financials
Anthem
($132; ANTM)
35.4
87
75
27
66
64
1
3
80
75
Health care
Cisco Systems
($27; CSCO)
139.4
72
81
67
44
66
0
3
78
78
Technology
Express Scripts
($86; ESRX)
58.8
48
65
87
80
70
0
3
75
93
Health care
Gilead Sciences
($107; GILD)
160.2
71
92
98
50
78
0
3
93

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