Trying To Limit Laggards

5/2/2016


We know stocks that score above 80 in Quadrix Overall average returns higher than the typical stock (see www.DowTheory.com/Go/Quadrix for details). But plenty of them underperform despite their high scores.

Because no quantitative system can consider all the forces that drive stock prices, some laggards are inevitable. Things like changes in regulatory climate, market share, or rivals' product lineups may not flow through to Quadrix until after they start showing up on financial statements, in some cases weeks or months after news hits the market.

Even stocks that seem to have everything can go on to underperform, sometimes without any obvious reason. This partly explains why we don't just buy high scorers, but instead use Quadrix to find high-potential stocks, then rely on individual company analysis to differentiate them.

In an attempt to improve our odds, we decided to gauge Quadrix from the opposite direction. We started with stocks in the top quintile (one-fifth) for 12-month returns, then considered their Quadrix scores at the start of the 12-month period, providing us with a peek at the top-performing stocks before they showed out. Here are a few things we learned:

• On average, over the last five years, 21.3% of S&P 1500 Index stocks scored above 80 Overall. Among the stocks that went on to deliver top 12-month returns, 24.3% scored above 80.

• High Overall scorers that went on to produce top returns averaged Earnings Estimates scores of 70.6, while those that went on to produce returns in the bottom half of the index averaged scores of 67.2. None of the other five category scores boasted so wide a differential. In fact, the top scorers averaged lower Value and Financial Strength scores. (Before you give up on Value, remember that the score's predictive power tends to be streaky and shouldn't stay down forever.)

• Only six individual Quadrix factors with five years of history averaged scores three points higher for top-performing stocks than for those with weak performance.

• Stocks with both high Overall scores and high scores in several of these six powerful factors slightly outperformed stocks with just high Overall scores, and substantially outperformed the average stock.

Given the myriad forces that affect stock prices, a perfect analysis system remains out of our (or anyone's) reach. But we never stop trying to squeeze excess return out of Quadrix, and every factor counts. With that in mind, the table below identifies stocks with high Overall scores as well as high scores in some of the factors that crop up often in stocks that outperform. Three intriguing names are reviewed below:

Alaska Air Group ($74; ALK) earned $1.45 per share in the March quarter, up 29% and $0.03 above the consensus. Revenue rose 6%, roughly in line with analyst
expectations. Low fuel costs (down 29% in the quarter) fattened profit margins, a trend that has helped airline results for the last two years.

Alaska trimmed its unit costs 11.7% in the quarter, managing a 1.2% decline excluding fuel. That operating efficiency, coupled with aggressive buybacks (share count down 5.2% over the last year) has kept profits rising at double-digit rates in 10 straight quarters.

The consensus projects profit growth of 15% in 2016, slowing to 3% in 2017, in part because of expectations that fuel costs will rise. Estimates don't take into account the planned $2.6 billion acquisition of Virgin America ($56; VA), expected to close late this year or early next year. Capacity rose 12.9% in the quarter, outstripping an 11.0% increase in traffic. The company expects capacity growth to slow to 11% in the June quarter and 8% for the year, with unit costs excluding fuel continuing to decline. Alaska is a Focus List Buy and a Long-Term Buy.


Biotech giant Biogen ($280; BIIB) scores below 50 in only one of the six scores featured in this story — 12-month total return. While the shares are still down 28% over the last year, gains made since declaring strong quarterly results on April 21 should drive the total-return score higher in the next Quadrix update.

The company boosted March-quarter sales 7%, paced by gains from its largest drug, Tecfidera for multiple sclerosis, and two hemophilia treatments launched last year. Per-share profits jumped 25% to $4.79 per share, topping the consensus by $0.33. Analysts expect profit growth of 11% this year and 7% next year, targets that seem overly conservative given Biogen's robust drug portfolio and expected product launches.

Despite Biogen's recent share-price gains, it trades at just 16 times trailing earnings, a 28% discount to the industry median and 44% below its five-year average P/E ratio. The company earns a Quadrix Value score of 74, well above the industry average of 43. Biogen is a Long-Term Buy.


Southwest Airlines ($46; LUV) earns a Quadrix Overall score of 100, a Quality score of 99, and a Reranked Overall score (one of our two sector-specific ranks) of 99, all good for tops among S&P 1500 airlines. Southwest earned its high Quality score via remarkably consistent growth. Sales have risen in each of the last 14 quarters and per-share profits in the last 12. The consensus projects more of the same — sales growth of 6% this year and 5% next year, with profits up 21% this year and 9% in 2017.

In the March quarter, Southwest earned $0.88 excluding special items, up 33% and topping the consensus by $0.04, while revenue increased 9% and operating cash flow 11%. Citing solid bookings in April, the company expects unit revenue to rise in the June quarter.

At 11 times estimated 2016 earnings, Southwest trades 15% above the industry median, a premium justified by the company's steady history and ability to grow traffic faster than capacity. However, Southwest's trailing P/E ratio of 12 is 36% below its three-year average of 18.9. Southwest is a Buy and a Long-Term Buy.

IMPROVE YOUR ODDS WITH HIGH SCORERS
The A-rated stocks below score above 50 in five or more of the six featured Quadrix factors — three-year growth in equity and net income, price/free cash flow, estimate revisions for this year and next year, and 12-month total return — and above 80 in at least two of the six. Recommended stocks are in bold.
------------------------------------------------- Quadrix Scores -------------------------------------------------
3-Year
Equity
Growth
Profit-Estimate
---- Revisions ----

Price/
Free
Cash Flow

3-Year
Net-
Income
Growth
12-Month
Total
Return
Company (Price; Ticker)
Next
Year
Current
Year
Quality
Earns.
Ests.
Overall
Sector
Alaska Air Group
($74; ALK)
96
64
81
63
90
89
97
49
99
Industrials
Applied Materials
($21; AMAT)
59
88
91
23
100
55
77
86
92
Technology
Biogen Idec ($280; BIIB)
96
56
74
56
89
19
98
65
90
Health care
Centene ($66; CNC)
89
84
73
68
100
39
98
96
96
Health care
Gilead Sciences
($101; GILD)
99
78
77
85
97
55
99
84
100
Health care
Goodyear Tire &
Rubber
($30; GT)
99
92
83
69
64
83
77
77
93
Cons.
discretion.
Home Depot ($136; HD)
97
82
86
29
77
86
96
94
73
Cons.
discretion.
Lear ($116; LEA)
90
88
96
73
33
57
92
94
98
Cons.
discretion.
LKQ ($34; LKQ)
86
81
90
38
70
91
97
98
93
Cons.
discretion.
Nvidia ($37; NVDA)
70
77
92
49
55
97
86
80
77
Technology
Owens Corning
($49; OC)
59
64
83
50
99
85
78
96
97
Industrials
Priceline ($1,354; PCLN)
97
92
81
49
76
78
99
36
78
Cons.
discretion.
Southwest Airlines
($46; LUV)
90
83
71
35
96
74
99
88
100
Industrials
Target ($83; TGT)
75
81
89
61
53
68
76
71
85
Cons.
discretion.
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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