Is Value Making A Comeback?

4/11/2016


Value is the most effective Quadrix category for people with long time horizons, though a Value strategy's short-term gyrations can test investors' patience.

Stocks in the top quintile for Value have outperformed the average S&P 1500 stock by an average of 2.4% in rolling 12-month periods since 1994, as shown in the chart below. But the Value score has underperformed by an average of 6.0% in the past 12 rolling periods.

Not surprisingly, most of the individual factors that comprise the Value score have also struggled recently. Only the price/free-cash-flow ratio has worked in the past 12 rolling periods, though not as effectively as it has worked since 1994.

Note that enterprise ratio divides earnings before interest, taxes, depreciation, and amortization (EBITDA) into enterprise value. We calculate enterprise value by adding a company's equity to its debt, then subtracting cash and short-term investments. 

Encouragingly, Value may be showing signs of a rebound. In February and March (one-month periods), the Value score showed more predictive power than any other category. Individual Value factors are also working so far in 2016, with the trailing P/E, P/E on next year's estimate, price/sales, price/cash-flow, and enterprise ratios delivering returns among the top 20 factors in Quadrix in each of the last two months. Price/free cash flow was moderately effective.

It's far too early to declare that Value has returned to favor, but this is an encouraging development. Below, we review one stock for each of the six key valuation metrics:

Trailing P/E ratio

Even as interest rates squeezed profits at many banks, J.P. Morgan Chase's ($59; JPM) earnings per share surged 9% in the past year. Its stock managed a flat total return — modest by most accounts, though higher than any other stock in its industry group, which posted a median loss of 11%. The stock trades at less than 10 times trailing earnings, in line with its five-year average and 5% below the median for S&P 1500 diversified banks.

Analysts expect J.P. Morgan's per-share profits to slump 6% this year before rebounding 17% in 2017. Yet the stock looks cheap from multiple angles, scoring in the top half of our research universe for nearly two-thirds of the factors that comprise our Value score. It seems like an opportune time to repurchase shares, and J.P. Morgan will be doing just that, as the Fed has approved it to buy back an additional $1.88 billion in stock through June. J.P. Morgan is a Long-Term Buy.

TRAILING P/E RATIO
Company (Price; Ticker)
Ratio
Factor
Score
Gilead Sciences ($97; GILD)
7.7
93
Goodyear Tire ($31; GT)
9.0
90
J.P. Morgan ($59; JPM)
9.2
90
Jabil Circuit ($18; JBL)
10.0
87
Lear ($106; LEA)
10.3
86
Jones Lang ($118; JLL)
11.6
82
Note: Factor scores are percentile ranks.

P/E on next-year estimate

Shares of Goodyear Tire & Rubber ($31; GT) have generated a total return of 15% over the past year, yet still rank among the cheapest of our recommended stocks for all six value metrics shown on these pages. The stock trades at just eight times estimated earnings for both 2016 and 2017 — at least 48% below the median for S&P 1500 consumer-discretionary stocks. Rising analyst estimates project 17% higher per-share earnings this year, followed by 6% growth in 2017.

Goodyear is generating strong profit growth amid sluggish sales, as operating profit margins expanded more than two percentage points to 15.2% last year, their highest level since at least 1980. This trend seems likely to continue, with management forecasting a 5% decline in raw-material costs this year, while its product mix should continue to improve. Global tire volumes are projected to rise 3%. Moreover, free cash flow is expected to be positive for a second straight year, and management suggested it could rise from the $636 million generated last year. Goodyear has reported positive annual free cash flow just twice in the past decade. Goodyear is a Buy and a Long-Term Buy.

P/E ON NEXT-YEAR ESTIMATE
Company (Price; Ticker)
Ratio
Factor
Score
Gilead Sciences ($97; GILD)
7.4
92
Jabil Circuit ($18; JBL)
7.8
91
Goodyear Tire ($31; GT)
8.0
90
Lear ($106; LEA)
8.5
89
J.P. Morgan ($59; JPM)
9.3
85
Southwest Airlines ($44; LUV)
9.8
83
Note: Factor scores are percentile ranks.

Price/sales ratio

Centene ($61; CNC) scores in the top 10% of stocks in our universe for price/sales ratio, one of the most effective Quadrix factors in the past decade and since 1994. At 0.3 times trailing sales, the stock trades 5% below its five-year average and 26% below the median for S&P 1500 managed-care stocks. Shares trade at 16 times estimated 2016 profits, a 7% discount to their peer-group median.

Centene reported 2015 sales of $22.76 billion and has generated annual revenue growth of 20% or more in each of the past five years. Newly acquired Health Net will add an additional $16.24 billion in annual revenue. Management's 2016 guidance, which will be updated later this month, currently targets revenue of $40.0 billion to $40.8 billion, implying 4% organic growth in 2016. The deal was completed later than Centene expected, which could lower the company's revenue target. Centene, earning an Overall rank of 97, is a Focus List Buy and a Long-Term Buy.

PRICE/SALES RATIO
Company (Price; Ticker)
Ratio
Factor
Score
Jabil Circuit ($18; JBL)
0.2
95
Centene ($61; CNC)
0.3
91
Kroger ($39; KR)
0.3
90
Lear ($106; LEA)
0.5
86
CDW ($42; CDW)
0.5
83
Goodyear Tire ($31; GT)
0.5
83
Note: Factor scores are percentile ranks.

Price/cash-flow ratio

Lear ($106; LEA) generates copious free cash flow, up 61% to $707 million in 2015, its third straight year of more than 35% growth. It has grown cash from operations more than 12% in each of the past three years.

Lear trades at six times operating cash flow, a 26% discount to its three-year average and nearly 50% below the median for S&P 1500 auto-parts suppliers. The stock also looks cheap based on price/cash flow, a Quadrix factor that uses a shorthand approximation of cash flow.

Looking ahead, rising analyst estimates project 11% higher per-share profits this year, followed by 10% growth in 2017. Despite its outstanding growth prospects, the stock ranks among the cheapest 15% of stocks in our research universe for valuation relative to current-year and next-year estimated earnings. Lear is a Focus List Buy and a Long-Term Buy.

PRICE/CASH FLOW RATIO
Company (Price; Ticker)
Ratio
Factor
Score
Jabil Circuit ($18; JBL)
3.7
93
Gilead Sciences ($97; GILD)
6.8
82
J.P. Morgan ($59; JPM)
7.4
79
Lear ($106; LEA)
7.6
79
Amerco ($341; UHAL)
8.2
75
Goodyear Tire ($31; GT)
8.8
72
Note: Factor scores are percentile ranks.

Price/free-cash-flow ratio

Gilead Sciences ($97; GILD) looks cheap from virtually every angle. The stock earns above-average scores for 86% of factors that comprise the Value score. Plus, it scores above 80 for 62% of the Value factors, including trailing P/E, P/E on next-year's estimate, price/cash flow, and price/free cash flow. The stock's trailing P/E of 7.7 lags its industry median of 21.1 and its own five-year average of 20. Shares trade at just 7.4 times estimated 2017 earnings, a steep 50% discount to its peer-group median.

Gilead's free cash flow jumped 44% to $17.71 billion last year, while its cash and marketable securities more than doubled to $26.21 billion. Gilead is putting some of its cash to work by agreeing to pay $400 million up front and up to $800 million in additional milestone payments to acquire an experimental drug intended to treat a fatty liver disease called non-alcoholic steatohepatitis, or NASH. Gilead is also developing its own treatments for NASH, which could eventually become a $35 billion market. Gilead is a Focus List Buy and a Long-Term Buy.

PRICE/FREE CASH FLOW RATIO
Company (Price; Ticker)
Ratio
Factor
Score
Gilead Sciences ($97; GILD)
7.9
87
F5 Networks ($104; FFIV)
11.8
76
Lear ($106; LEA)
12.3
75
Apple ($111; AAPL)
12.1
75
Goodyear Tire ($31; GT)
14.1
69
Centene ($61; CNC)
15.1
67
Note: Factor scores are percentile ranks.

Enterprise ratio

With a market value of just $3.57 billion, Jabil Circuit ($18; JBL) could become a tempting takeover target for a big technology company struggling to grow. Jabil's low valuation would be a big draw. It has an enterprise ratio of 3.8, among the cheapest 3% of technology stocks in the index and the cheapest 10% of all stocks in our research universe. The enterprise ratio equals a company's stock-market value plus total debt minus cash, then divided by earnings before interest, taxes, depreciation, and amortization (EBITDA). Analysts often use the enterprise ratio to estimate the cost of purchasing a company.

We like the stock on its own merits. Jabil issued surprisingly weak May-quarter guidance, attributed to weaker smartphone demand, yet seems capable of resuming per-share-profit growth in the August quarter. Shares trade at just nine times estimated year-ahead earnings, 49% below the technology sector median. Jabil is a Buy and a Long-Term Buy.

ENTERPRISE RATIO
Company (Price; Ticker)
Ratio
Factor
Score
J.P. Morgan ($59; JPM)
2.7
96
Jabil Circuit ($18; JBL)
3.8
94
Goodyear Tire ($31; GT)
5.2
87
Lear ($106; LEA)
5.7
85
Southwest Airlines ($44; LUV)
5.6
85
Alaska Air ($80; ALK)
5.9
84
Note: Factor scores are percentile ranks.

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