In Search Of The Least Imperfect

2/27/2017


Investors consider dozens of financial metrics to evaluate stocks, along with qualitative observations less easy to measure. But no stock is perfect. Each one carries the flaws of fallible management execution, exposure to events out of its control, and the potential that current valuations fail to properly discount future risks.

All too often, individual pieces of data conflict with each other. It can be more than enough to make anyone's head spin. As F. Scott Fitzgerald once wrote, "The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

To keep our wits and simplify the investment process, we created Quadrix, which uses about 100 different factors to measure stocks against each other. It serves as our first screen for evaluating stocks. It can also help us uncover stocks with improving fundamentals but unloved by analysts.

ANALYST RECOMMENDATIONS
The stocks least loved by Wall Street analysts earn the highest scores in Quadrix for the Analyst Rating rank. These S&P 1500 stocks look attractively valued compared to other stocks in the index, especially those most favored by analysts. A consensus rank of 1 equates to a Strong Buy rating, followed by 2 for a Buy, 3 for a Hold, 4 for a Sell, and 5 for a Strong Sell. All numbers are averages.
Analyst
Rating
Rank
------- P/E Ratio -------
--------- Quadrix Scores ---------
Quintile
Analyst
Rating
Trailing
Forward
Momen-
tum
Value
Overall
Top quintile
90
3.1
22.3
21.8
47
57
55
Second quintile
74
2.7
22.1
22.2
49
60
59
Third quintile
60
2.4
22.6
21.5
53
57
60
Fourth quintile
42
2.0
23.0
21.9
50
56
56
Bottom quintile
21
1.6
25.1
23.7
57
51
59
No score
36.5
23.9
55
57
65
S&P 1500
57
2.4
23.1
22.2
51
56
58
Note: Quadrix scores are percentile ranks, with 100 the best.

 

EARNINGS PREDICTABILITY
Quadrix rewards stocks that generate highly consistent profits, as measured by the Earnings Predictability score. S&P 1500 stocks with the steadiest profits look expensive relative to trailing earnings but more reasonable based on estimated year-ahead earnings. All numbers are averages.
Earnings
Predictability
Rank
-------- P/E Ratio --------
---------- Quadrix Scores ----------
Quintile
Trailing
Forward
Momen-
tum
Value
Overall
Top quintile
94
23.8
22.4
58
56
69
Second quintile
78
21.9
21.2
54
57
63
Third quintile
58
23.7
22.5
51
56
57
Fourth quintile
36
23.4
22.8
47
56
52
Bottom quintile
13
22.9
22.6
45
55
48
No score
21.4
19.3
52
58
61
S&P 1500 Index
56
23.1
22.2
51
56
58

 

3-YEAR TOTAL RETURN
The Quadrix score for three-year total return is a contrarian factor identifying stocks with the worst performance over that period. S&P 1500 stocks with the worst returns look cheap based on trailing earnings and fairly valued based on estimated year-ahead earnings. All numbers are averages.
3-Year
Total
Return
Score
3-Year
Total
Return
(%)
------- P/E Ratio -------
--------- Quadrix Scores ---------
Quintile
Trailing
Forward
Momen-
tum
Value
Overall
Top quintile
79
(15)
21.0
21.8
34
61
44
Second quintile
56
3
22.1
21.1
46
63
56
Third quintile
40
11
22.7
21.7
50
58
59
Fourth quintile
25
17
24.4
23.5
57
53
62
Bottom quintile
10
29
24.8
23.2
67
48
68
No score
23.8
20.5
55
54
60
S&P 1500
42
9
23.1
22.2
51
56
58

 

5-YEAR TOTAL RETURN
The Quadrix score for five-year total return is a contrarian factor identifying stocks with the worst performance over that period. S&P 1500 stocks with the worst returns look cheap based on trailing earnings and fairly valued based on estimated year-ahead earnings. All numbers are averages.
5-Year
Total
Return
Score
5-Year
Total
Return
(%)
------- P/E Ratio -------
--------- Quadrix Scores ---------
Quintile
Trailing
Forward
Momen-
tum
Value
Overall
Top quintile
78
(6)
21.9
21.9
35
58
41
Second quintile
57
8
22.4
22.2
46
61
55
Third quintile
41
13
23.0
22.7
50
57
58
Fourth quintile
26
19
22.8
21.1
58
54
64
Bottom quintile
10
30
24.4
22.7
65
52
70
No score
25.4
22.1
52
55
60
S&P 1500
42
13
23.1
22.1
51
56
58

We track a handful of contrarian Quadrix factors, meaning that we reward companies for lagging in a given metric. Our three- and five-year total return scores favor the weakest-performing stocks over those periods, while the Analyst Rating score rewards stocks held in the lowest esteem by analysts. All three factors are based on the idea of mean reversion — that stock prices and analyst sentiment will eventually bounce back to market norms.

Some academic research supports this theory. A 2012 study by Citigroup ($61; C) found that in the prior decade, the 20% of stocks most liked by analysts in the MSCI All-Country World Index averaged 7% returns. The lowest-rated 20% of global stocks returned 6% on average. Both groups performed significantly better than the overall stock market, up 2%, signaling that many stocks in the middle 60% were laggards. But the study did uncover a notable exception. In the U.S., Citigroup found that sell-rated stocks tended to outperform the top picks. In fact, the top picks by U.S. analysts performed worse than in any other country.

In Quadrix, the stocks most hated by analysts have modestly outperformed since 1994. That indicator has been especially effective recently. A strategy of buying the worst performers over the past three and five years has proved far less effective.

We highlight recommended stocks with above-average scores for at least one of the contrarian factors in the table below. They also have a history of delivering fairly steady profits, which could mitigate downside risk.  Three of the stocks are reviewed below:

Biogen's ($288; BIIB) shares and operating momentum have headed in opposite directions over the past three years. In a period when the stock posted an annualized loss of 3%, the company has managed annualized growth of 18% for sales and 29% for per-share profits.

However, recent developments for the drugmaker are encouraging. Biogen won U.S. approval to sell Spinraza, a spinal muscular atrophy drug. It reached a licensing deal for Tecfidera, clearing up some of the legal uncertainty hanging over its top multiple sclerosis medication. And it reported positive results for an experimental treatment for Alzheimer's disease. Encouragingly, analyst estimates are rising, with the consensus projecting 4% higher earnings per share in 2017 and 7% in 2018. Biogen is a Buy and a Long-Term Buy.


CBS ($67; CBS) shares have generated a modest annualized total return of 3% over the past three years. Sluggish share-price action has continued into 2017, with the stock up just 6%. Yet annual per-share profits have increased in seven of the past eight years, including 24% growth in 2016.

CBS says advertising revenue has picked up in recent months, following a disappointing December quarter. Retransmission fees are projected to grow 25% this year, potentially pushing profit margins higher. Long-term growth prospects are also encouraging. Its over-the-top services, which provide online streaming of CBS and Showtime shows, are rapidly adding paying subscribers. CBS says the services now surpass 2 million subscribers, putting them on pace to break management's goal of 8 million subscribers by 2020. CBS,which yields 1.1%, is a Focus List Buy and a Long-Term Buy.


Citrix Systems ($80; CTXS) earns above-average ranks for two contrarian factors in Quadrix: its relatively weak five-year total return and average analyst rating. The stock has risen at an annualized rate of 6% over the past five years. Shares have fallen 10% in the past three months and look attractive at 17 times estimated 2017 profits, below the S&P 1500 technology sector's median P/E of 20.

On average, Wall Street analysts give Citrix a lower rating than most of our other stocks. The company has also recently seen a sharp decline in profit estimates, largely due to its GoTo spin-off on Feb. 1. Management says GoTo was more capital-intensive than Citrix's other businesses, and by jettisoning the unit, Citrix expects capital expenditures to fall by one-third this year, leaving more room for stock buybacks and possibly even a dividend initiation. Citrix is a Buy and a Long-Term Buy.

TOP CONTRARIAN PICKS
We screened for stocks with high earnings consistency that have fallen out of favor with analysts or investors.
---- P/E Ratio ----
Annualized
Total Return
-------------------------------- Quadrix Scores --------------------------------
Company (Price; Ticker)
Trailing
Forward
3
Year
(%)
5
Year
(%)
Average
Analyst
Rating
3-Yr.
Total
Return
5-Yr.
Total
Return
Earnings
Predict-
ability
Analyst
Rating
Momen-
tum
Value
Overall
Biogen ($288; BIIB)
14
14
(1)
22
2.0
63
20
98
41
85
85
98
CBS ($67; CBS)
16
15
1
19
1.6
59
27
93
21
32
72
68
Citizens Financial
($38; CFG)
19
17
NA
NA
2.2
NA
NA
83
54
96
72
98
Citrix Systems
($80; CTXS)
15
17
21
6
2.6
17
63
74
72
42
80
82
Disney ($110; DIS)
20
19
13
23
2.3
34
17
97
57
24
65
70
F5 Networks
($145; FFIV)
19
17
9
2
2.6
44
70
96
71
69
65
89
Kroger ($33; KR)
15
16
23
25
2.2
14
14
96
54
24
84
63
LabCorp of America
($139; LH)
16
14
14
9
2.0
31
54
92
35
32
81
64
Lear ($143; LEA)
10
9
24
27
2.6
12
11
89
69
84
97
100
LKQ ($33; LKQ)
19
18
3
14
1.4
55
39
99
14
79
78
85
QuintilesIMS ($77; Q)
24
17
14
NA
2.4
33
NA
86
60
39
48
40
VMware ($92; VMW)
18
19
(2)
(2)
2.3
64
76
89
56
70
62
92
Note: NA denotes not available.

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