Top 10 Not Enough? We Triple It

10/31/2016


There are nearly as many ways to look at stocks as there are stocks.

Everybody has a favorite approach or a few key statistics they use to identify exciting prospects. Just because someone else uses a strategy different from yours doesn't mean their approach won't work. By design, our Quadrix rating system views stocks from dozens of angles, which suggests we take an inclusive and agnostic approach to stock analysis.

Basically, we'll consider just about any data that provides us with an edge, including three of the most common lenses investors use to assess stocks: growth, value, and income. With these analysis angles in mind, we conducted a triple screen of our buy lists to select our top 10 stocks for each category.

Only one stock qualified for the top 10 in all three categories: CVS Health ($88; CVS). In the following paragraphs, we dig into the screens and present a couple of intriguing stocks in each category.

Growth

Here, we considered the following statistics:

• Twelve-month growth in sales, per-share profits, and operating cash flow.

• Estimated profit growth for the year ahead and the next five years.

• Quadrix Momentum scores, which consider mostly short-term growth metrics and a couple gauges of profit-estimate trends.

• Individual Quadrix scores for earnings-estimate revisions for the current quarter and the next quarter. These two factors have been effective over the last five and 10 years at identifying stocks that outperform.

While none of our stocks was at the top of the list in all of the eight growth metrics, the ones in the growth table below look good based on multiple statistics. The 10 growth leaders average Momentum scores of 86 and have each delivered at least 8% profit growth over the last year. All but two are expected to grow profits at a double-digit rate in the year, while the consensus projects double-digit annualized profit growth for all but one of them over the next five years.

Mohawk Industries ($187; MHK), the largest U.S. maker of flooring with a 23% share of the market, has grown per-share profits 30% over the last 12 months, with sales up 10% and operating cash flow 44%. Profits rose in 19 straight quarters, and the profit consensus for both this year and next year has risen over the last three months. Analyst expect Mohawk's earnings to rise 13% over the next 12 months and 10% annually over the next five years.

Mohawk earns a rank of 94 in Momentum, but also scores a solid 72 in Value. While Mohawk trades at a premium to the typical home-furnishings stock, its trailing price/earnings ratio of 16 is 27% below its own five-year average. The stock also trades at a 27% discount to its five-year average for price/operating cash flow. Mohawk, a Focus List Buy and a Long-Term Buy, plans to release September-quarter earnings Nov. 4.


Zions Bancorp ($32; ZION) grew per-share profits 39% to $0.57 in the September quarter, surpassing the consensus of $0.43. Net interest income jumped 10% while net interest margin, an indicator of lending profitability, rose to 3.4% from 3.1%. Net loans and leases rose 6%, and total deposits increased 4%. Provision for potential loan losses rose 3% from the same time last year but fell 45% from the June quarter.

The consensus calls for per-share-profit growth of 21% in the December quarter and 19% next year, as profitability gains augment mid-single-digit revenue growth. Aggressive cost controls have paid off in recent quarters, with adjusted noninterest expense up 3% for the quarter and down 1% for the nine months ended September. Zions is a Focus List Buy and a Long-Term Buy.

TOP 10 GROWTH STOCKS
Growth, Last
-- 12 Months --
Est. EPS
--- Growth ---
-- Quadrix Scores --
 
Sales
(%)
EPS
(%)
Oper.
Cash
Flow
(%)
Year
Ahead
(%)
5 Years
(Annual.)
(%)
Momen-
tum
EPS Revisions,
Company (Price; Ticker)
Curr.
Qtr.
Next
Qtr.
AbbVie ($61; ABBV)
18
29
77
9
13
79
54
48
Alphabet
($822; GOOGL)
17
28
12
17
17
94
90
84
Centene ($64; CNC)
65
36
(45)
21
16
82
39
59
Citrix Systems
($84; CTXS)
6
56
21
(2)
11
90
85
70
CVS Health ($88; CVS)
15
11
16
18
12
86
85
51
D.R. Horton ($29; DHI)
14
23
487
15
13
75
52
77
LabCorp of Amer.
($126; LH)
32
8
63
11
11
78
68
71
Mohawk ($187; MHK)
10
30
44
13
10
94
86
93
QuintilesIMS ($73; Q)
7
27
69
14
12
90
76
97
Zions Bancorp
($32; ZION)
11
63
NA
22
8
96
90
90
Note: Quadrix scores are percentile ranks, with 100 the best.  NA Not available because banks don't declare cash flow.

Value

Our value screen considered eight numbers:

• Price/earnings, both current and relative to the five-year average.

• Price/operating cash flow, both current and relative to the five-year average.

• PEG (price/earnings-to-growth) ratio.

• Quadrix Value scores, which look at a variety of valuation ratios relative to other stocks, as well as relative to historical norms.

• Individual Quadrix scores for price/free cash flow and price/sales, among the most effective Value factors over the last five and 10 years.

Our 10 top value stocks average Value scores of 86. All 10 trade at least 6% below their five-year average P/E ratio, and six of the 10 trade 12% below their historical average price/operating-cash-flow ratio.

Biogen ($296; BIIB) earned $5.19 per share in the September quarter, up 16%. In the last five quarters, the company has topped analyst expectations by an average of 10%. Sales rose 6%, slightly above expectations, helped by a 10% increase in Tecfidera revenue. Sales of hemophilia drugs, slated for a spin-off in early 2017, jumped 38%.

Investors need not pay up for Biogen's growth. At 14 times expected 2017 earnings, Biogen trades at a 24% discount to the median biotechnology stock in the S&P 1500. The stock also trades at a 33% discount to its own three-year average for trailing price/earnings and price/operating cash flow.

While projecting the future success of drugs in development is risky at the best of times, one of Biogen's more appealing attributes is its development of a medication that addresses the cause of Alzeheimer's disease; rival drugs treat only the symptoms. Of course, the drug's success is far from guaranteed, with more clinical trials under way. But with Alzheimer's afflicting 5.4 million Americans and 44 million people worldwide, the potential rewards of an effective treatment are huge. Biogen is a Buy and a Long-Term Buy.


Homebuilders as a group are unusually cheap, averaging forward P/E ratios of 12, 30% below the average for all consumer-discretionary stocks in the S&P 1500. But even within its inexpensive group, D.R. Horton ($29; DHI) stands out. Its forward P/E of 11 is 9% below the industry average. D.R. Horton also trades 18% below its own three-year average for trailing P/E ratio, 13% for price/sales, and 17% for enterprise ratio. The stock's price/earnings-to-growth ratio (forward P/E divided by estimated long-term growth rate) of 0.8 is among the cheapest on our buy lists.

D.R. Horton has profited from improving fundamentals in the housing market, which boasts strong demand and rising prices. In the three months ended August, Americans purchased nearly 462,000 new homes, up 25% from a year earlier and the strongest three-month showing in more than eight years. D.R. Horton plans to release September-quarter earnings Nov. 8; analysts expect profit growth of 26% on 21% higher sales. The stock is a Focus List Buy and a Long-Term Buy.

TOP 10 VALUE STOCKS
Price/Earnings
Price/Operating
---- Cash Flow ----
----- Quadrix Scores -----
Company (Price; Ticker)
Trailing
Versus
5-Year
Average
Trailing
Versus
5-Year
Average
PEG
Ratio
Value
Price/
Free
Cash
Flow
Price/
Sales
Alaska Air Group
($71; ALK)
10
0.81
5.5
0.99
2.8
90
78
57
Biogen ($296; BIIB)
16
0.57
16.7
0.71
1.4
76
52
16
CVS Health
($88; CVS)
16
0.87
10.0
0.80
1.1
83
56
85
D.R. Horton
($29; DHI)
13
0.59
17.9
NA
0.8
85
39
72
Kroger ($31; KR)
14
0.94
5.8
0.88
1.6
86
35
94
Lam Research
($98; LRCX)
15
0.72
12.8
0.98
1.0
68
59
39
Lear ($121; LEA)
9
0.87
5.3
0.70
0.8
97
86
88
McKesson
($159; MCK)
12
0.63
7.1
0.57
1.0
93
84
96
Owens Corning
($50; OC)
15
0.69
5.9
0.53
1.2
89
72
69
Southwest Airlines
($38; LUV)
10
0.55
6.3
0.96
0.9
93
63
64
Note: Quadrix scores are percentile ranks, with 100 the best.  The PEG (price/earnings-to-growth) ratio represents the forward P/E divided by the expected five-year profit-growth rate.  NA Not available because of a lack of historical cash-flow data.

Income

Here are the criteria for our income screen:

• Dividend yield.

• One- and five-year dividend growth.

• Two payout ratios, expected year-ahead dividends as a percentage of trailing 12-month earnings and as percentage of trailing free cash flow.

• One- and five-year growth in free cash flow, numbers that reflect a company's ability to generate extra cash, and thus keep the dividend rising.

We didn't simply select the highest-yielding stocks, as some of them don't deliver the type of growth in free cash flow that we prefer, or haven't boosted the dividend aggressively enough. However, all 10 stocks yield at least 1%, and all have grown their payouts at a rate of at least 11% annualized over the last five years, if they've paid a dividend that long. All but one pays out less than half of its earnings in dividends.

Since initiating its dividend in 2013, Alaska Air Group ($71; ALK) has nearly tripled its quarterly payout to $0.275 per share, equating to a yield of 1.5%. With the payout accounting for just 15% of trailing earnings and 14% of free cash flow, the airline seems capable of continued dividend growth.

In the September quarter, Alaska earned $2.20 per share on an adjusted basis, up 2% and $0.13 above the consensus. Revenue rose 3%, slightly above expectations. Traffic and capacity both rose 8.1% for the quarter. The airline reiterated expectations for 3% capacity growth in the fourth quarter. Load factor (percentage of seats filled with paying passengers) rose in September, a trend the company expects to continue through the end of the year. Bookings for October have been strong.

Alaska pushed back the target date of its planned purchase of Virgin America ($55; VA) to April 4 because of regulatory scrutiny but still professes confidence the deal will get done. We recommended Alaska before it offered to buy Virgin and aren't concerned about the delay — or the possibility the deal will fall through. Alaska is a Buy and a Long-Term Buy.


J.P. Morgan Chase ($69; JPM) yields 2.8%, third-highest among our recommended stocks. Over the last five years, the financial-services giant has grown the payout at an annualized rate of 11%, yet the dividend accounts for just one-third of earnings. While any changes in J.P. Morgan's dividend policy must be approved by the Federal Reserve, we expect the company to continue raising the dividend in coming years.

In the wake of an 8% revenue gain and better-than-expected profits in the September quarter, analyst earnings estimates have inched higher. The consensus calls for a 5% rise in profits in the current quarter, followed by a gain of 6% in 2017. J.P. Morgan is delivering strong loan growth while retaining solid credit quality, and the company is poised to benefit from interest-rate hikes. The stock is a Long-Term Buy.

TOP 10 INCOME STOCKS
Dividend
--- Growth ---
-- Div. As % Of --
Free-Cash-
-- Flow Growth --
Company (Price; Ticker)
Indicated
Dividend
($)
Yield
(%)
1
Year
(%)

5
Years
(%)

Earnings
(%)
Free
Cash
Flow
(%)
1
Year
(%)
5 Years
(Annual.)
(%)
AbbVie ($61; ABBV)
2.28
3.7
20
NA
49
86
279
(8)
Alaska Air Group
($71; ALK)
1.10
1.5
35
108
15
14
193
26
CVS Health ($88; CVS)
1.70
1.9
19
24
32
33
16
7
D.R. Horton
($29; DHI)
0.32
1.1
22
19
14
27
NA
NA
EQT Midstream Part.
($77; EQM)
3.12
4.1
45
78
57
NA
NA
NA
J.P. Morgan Chase
($69; JPM)
1.92
2.8
8
11
33
NA
NA
NA
Lam Research
($98; LRCX)
1.20
1.2
42
NA
19
19
35
12
Lear ($121; LEA)
1.20
1.0
16
27
9
7
79
22
Southwest Airlines
($38; LUV)
0.40
1.0
21
74
10
12
242
5
Zions Bancorp
($32; ZION)
0.32
1.0
35
56
19
NA
NA
NA
Notes: The indicated dividend assumes the current quarterly dividend will be paid in each of the next four quarters.  NA Not available because some companies don't declare free cash flow or generated negative free cash flow in at least one of the periods; or because the company has been paying a dividend for less than five years.

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