Factor Madness

3/21/2016


At this time of year, many Americans fall under the spell of March Madness. We suddenly become experts about college basketball teams whose mascots we couldn't name a few weeks ago. We speak in strange dialects about high-ball screens and dribble penetration. We review each team's recent performance and body of work over the course of the season. And we hope that this process will help us identify squads capable of making a deep run in the NCAA tournament.

As basketball fans know far too well, a great resume does not guarantee a championship. But focusing on teams with a strong track record can improve your chances.

QUADRIX FACTORS: OUR SWEET 16
Our 16 most effective Quadrix factors for the S&P 1500 Index are shown below. Unless noted below, returns for all factors are since Dec. 1994. Winning percentage represents the percentage of periods with outperformance.
---------------- Average 12-Month Outperformance ----------------
Since Inception
(Max 243
Periods)
10 Years
(120 Periods)
5 Years
(60 Periods)
1 Year
(12 Periods)
Quadrix Factor
Avg.
(%)
Rank
Avg.
(%)
Rank
Avg.
(%)
Rank
Avg.
(%)
Rank
Winning
Percen-
tage
High/low consensus, curr. yr. *
1.7
20
2.1
3
1.5
5
5.0
6
62
EPS revisions, current yr. **
2.4
10
NA
NA
NA
NA
5.1
5
77
Beta
(1.8)
177
(1.6)
104
1.4
7
7.1
1
47
EPS revisions, current qtr.
2.8
6
0.6
31
1.9
3
3.7
13
73
EPS revisions, next qtr.
2.0
12
0.1
47
1.6
4
3.1
20
67
Gross profitability ***
4.3
1
NA
NA
NA
NA
4.8
7
88
5-yr. equity growth
1.1
33
0.7
24
1.9
2
3.5
16
62
3-yr. equity growth
0.7
54
0.8
22
2.0
1
2.6
24
59
Enterprise ratio
3.1
3
1.5
6
(0.8)
81
(7.8)
185
66
P/E ratio
2.5
9
0.5
34
(0.6)
70
(5.2)
169
56
P/E on next-yr. est.*
1.8
17
1.5
5
0.5
31
(4.8)
165
47
Price/free cash flow
3.2
2
0.9
20
1.0
15
1.7
39
65
Price/sales
3.1
4
3.5
1
1.2
11
(1.6)
116
59
P/E to 5-yr. median
1.2
30
1.5
7
(1.0)
86
(4.1)
160
45
P/E on next-yr. to 3-yr median*
1.9
15
2.3
2
(1.3)
102
(2.8)
144
50
Price/sales to 5-yr. median
2.7
7
1.3
12
(3.2)
126
(9.7)
190
40
* Inception date February 2004.     ** Inception date June 2010.     *** Inception date November 2013.     NA Not available.

In a somewhat similar vein, we constantly review what is working with our Quadrix stock-rating system. Above we present 16 factors that have been especially effective, either recently or over a long time horizon. And in the spirit of March Madness, we try to handicap which ones are most likely to outperform going forward.

Favorites

Price/free cash flow (Value category): Free cash flow is tougher to manipulate than earnings, though it can vary greatly from quarter to quarter. It can also turn negative, especially for younger companies and those with operations requiring significant capital investment. Price/free cash flow ranks second among all factors, with top scorers outperforming the average stock in the S&P 1500 Index by an average of 3.2% in rolling 12-month periods since 1994. It is also the only Value statistic to work over the last 12 rolling periods. At 7.5 times trailing free cash flow, Gilead Sciences ($90; GILD) is our only recommended stock to score above 80 for this factor.

Price/sales (Value): Even when profits turn negative, sales stay positive, so the price/sales ratio remains relevant for almost all stocks in all markets. Price/sales has delivered the best performance of any factor over the last 10 years, with top scorers averaging outperformance of 3.5%.

High/low consensus, current year (Earnings Estimates): This factor measures whether analysts tend to agree about the company's prospects, as shown by the distribution of profit estimates. A tight spread suggests more analyst agreement and earns a higher score.

This is the only factor to deliver top 10 performance over the last 10, five, and one years, as well as during the last single 12-month period. Among our recommended stocks, CDW ($41; CDW) earns a score of 74, with 11 analysts contributing to its consensus.

EPS revisions, current quarter; EPS revisions, next quarter (Momentum): Stock prices tend to rise as analysts become more bullish on a company's outlook. With that in mind, these factors consider the percentage of analysts who have raised or lowered a stock's quarterly profit estimates in the past 90 days. Among the Quadrix factors we've tracked since December 1994, none has been more consistently effective than EPS revisions for the current quarter, outperforming in 73% of periods. EPS revisions for the next quarter ranks second at 67%.

Gross profitability (Quality): Gross profitability (gross profit divided by total assets) has been our top-ranked factor since its inception, generating average 12-month outperformance of 4.3% and beating the average stock in 88% of 12-month periods. However, the factor is also unproven; we introduced gross profitability in November 2013, and its durability through different types of markets remains unclear. We recommend seven stocks that score above 80 for gross profitability, including Robert Half International ($43; RHI), which earns a rank of 99.

Contenders

EPS revisions, current year (Earnings Estimates): This factor has outperformed by an average of 5.1% in the past 12 periods, fifth-best in our research universe. Initiated in June 2010, this factor's short history leaves doubts about its long-term effectiveness. But it has so far proved remarkably consistent, reflected by a winning percentage of 77% (second- best among our Sweet 16 factors).

5-year equity growth; 3-year equity growth (Quality): Stocks with outstanding track records for three- and five-year equity growth have consistently outperformed. Equity, also called book value, reflects the value of a company's assets minus its liabilities, or the amount of the company financed by common or preferred shares. These two factors are the top ranked for the past five years and have also worked well in the past year. More of our recommended stocks score above 80 for these two factors than any others presented here. Alaska Air Group ($81; ALK), Apple ($106; AAPL), Biogen ($251; BIIB), CDW, Gilead, Goodyear Tire & Rubber ($33; GT), and Shire ($152; SHPG) earn ranks of at least 95 for both.

P/E (Value): The P/E ratio means nothing unless per-share profits are positive. Five percent of S&P 1500 stocks and 33% of the index's energy companies delivered a loss in the past 12 months, rendering the factor invalid for those stocks. P/E ranks ninth among all Quadrix factors since inception, but like most Value factors, it has performed poorly recently. At nine times trailing earnings, Jabil Circuit ($22; JBL), ranks among the cheapest 20% of stocks in our research universe and the cheapest 5% in the S&P 1500 technology sector.

Enterprise ratio (Value): The enterprise ratio equals earnings before interest, depreciation, and amortization (EBITDA) divided by enterprise value, which equals equity plus debt minus cash and short-term investments. EBITDA is often positive even when earnings per share is negative, meaning the enterprise ratio can prove useful when P/E does not. The factor has worked more often than any other Value factor, reflected by its 66% winning percentage since 1994. But few Quadrix factors have fared worse in recent years.

Stocks with the lowest enterprise ratios lagged by an average of 11.6% over the past 12 months, though they performed well in the month of February, suggesting the factor may be getting back on track. Eight of our stocks score above 80 for enterprise ratio, including Alaska Air, Goodyear, Lear ($112; LEA), and Southwest Airlines ($44; LUV).

P/E on next-year estimate (Value): Unlike most valuation ratios, this factor is forward-looking. Of course, that means it carries some risk that the consensus is wrong. Although one of just a handful of Value factors to deliver outperformance over the past five years, this metric's performance tends to be quite volatile, with a winning percentage of just 47%.

Pretenders

Beta (not used to compute score): Beta measures a stock's volatility relative to the market. Amid global gyrations, investors have recently piled into low-volatility stocks, making beta the top factor in Quadrix in the past year. But the recent rally has left many low-beta stocks looking unusually expensive. Moreover, beta's long-term performance stinks. It has lagged by an average of 1.8% since 1994 — none of the other 16 factors has underperformed since their inception. Among our recommended stocks, C.H. Robinson Worldwide ($73; CHRW) has the lowest beta (0.4, for a factor score of 87), while CBRE Group ($27; CBG) has the highest (2.1, for a score of 8).

P/E to 5-year median; P/E on next-year estimate to 3-year median; Price/sales to 5-year median (Value): These relative metrics can provide context for investors. All three have proved effective over the long term, especially in the past 10 years. But they have performed poorly in the past five- and one-year periods. These relative valuation ratios see lower winning percentages than most of the other factors we present here. Price/sales to 5-year median is the most volatile of the 16 top factors, producing a 12-month outperformance as high as 113% in one period, while lagging by as much as 15% at worst.

HIGH SCORES
At least one recommended stock scores above 80 for each of our Sweet 16 Quadrix factors. Gilead ($90; GILD) scores in the top quintile for 11 of these factors — more than any of our other stocks. Below we present our five top-scoring stocks for each metric, if there are more than five.
Company (Ticker)
Rank
 
Company (Ticker)
Rank
 
Company (Ticker)
Rank
 
Company (Ticker)
Rank
High/low consensus,
current year 
 
EPS revisions, curr. yr. 
 
Price/sales 
 
P/E on next-yr. est.
to 3-yr. median 
Amerco (UHAL)
92
Alaska Air (ALK)
96
Jabil Circuit (JBL)
95
Gilead Sciences
(GILD)
98
Gross profitability 
Nvidia (NVDA)
96
Centene (CNC)
91
Biogen (BIIB)
96
Robert Half (RHI)
99
Amerco (UHAL)
96
Kroger (KR)
90
Southwest Airlines
(LUV)
90
C.H. Robinson
(CHRW)
96
Disney (DIS)
93
Lear (LEA)
86
Skyworks (SWKS)
90
Kroger (KR)
95
Lear (LEA)
91
CDW (CDW)
83
Shire (SHPG)
89
F5 Networks (FFIV)
95
5-year equity growth 
Price/sales to 5-yr.
median
3-year equity growth 
Foot Locker (FL)
94
CDW (CDW)
99
Gilead Sciences
(GILD)
81
Gilead Sciences
(GILD)
99
EPS revisions, curr. qtr.
Goodyear (GT)
99
P/E to 5-yr. median 
Goodyear (GT)
99
Amerco (UHAL)
98
Gilead Sciences
(GILD)
98
Gilead Sciences
(GILD)
97
Biogen (BIIB)
96
Nvidia (NVDA)
95
Apple (AAPL)
97
Biogen (BIIB)
93
Apple (AAPL)
95
Alaska Air (ALK)
93
Biogen (BIIB)
95
Jones Lang (JLL)
92
Shire (SHPG)
95
Southwest Airlines (LUV)
85
Price/earnings 
Southwest Airlines
(LUV)
92
Enterprise ratio 
Centene (CNC)
84
Gilead Sciences
(GILD)
93
Robert Half (RHI)
91
J.P. Morgan (JPM)
96
EPS revisions, next qtr.
Goodyear (GT)
90
P/E on next-yr. est. 
Jabil Circuit (JBL)
92
Amerco (UHAL)
98
J.P. Morgan (JPM)
89
Gilead Sciences
(GILD)
93
Goodyear (GT)
87
Nvidia (NVDA)
96
Lear (LEA)
86
Jabil Circuit (JBL)
91
Southwest Airlines
(LUV)
87
Alaska Air (ALK)
95
Jabil Circuit (JBL)
83
Goodyear (GT)
90
Alaska Air (ALK)
85
Centene (CNC)
91
Price/free cash flow 
Lear (LEA)
89
Beta 
Southwest Airlines
(LUV)
91
Gilead Sciences
(GILD)
88
J.P. Morgan (JPM)
85
C.H. Robinson
(CHRW)
87

 


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