A Narrow View On Estimates

3/20/2017


Most of us know better than to buy a stock before checking out trends related to its profit estimates.

Our Quadrix Earnings Estimates score focuses on nothing but these trends. But even if a stock scores well in Earnings Estimates, you should review the estimates in detail before making a move. We all know to check for a couple basics:

• The type of growth expected. Do the targets make sense, or are they too conservative or too aggressive?

• The direction of those estimates. Of course, we like to see profit targets rising, which reflects increasing optimism about a company's prospects.

But there's a third trend, one investors might not think to check. The spread between the high and low estimate.

Our research suggests stocks with a narrow spread tend to outperform the market. Sometimes it's fun and exciting to invest in stocks with a wide range of possible outcomes, figuring most analysts don't know what's happening and might be underselling their potential. Then again, those analysts could instead be too optimistic. A tight estimate spread suggests analysts are probably seeing the same characteristics in a stock, and possibly that company management provides fairly specific guidance.

Quadrix considers two measurements of estimate dispersion, one for the current fiscal year and one for the next year.

In most cases, uncertainty is the enemy of wise investment decisions. And while analysts are often wrong about a company's prospects, it's less likely that all of them are wrong in the same direction.

Our estimate-dispersion metrics consider the difference between the high and low per-share-profit estimates compared to the average estimate. A spread of $0.50 between the high and low targets signals a lot of uncertainty when the average profit estimate is $1.00 — and much less when the consensus is $5.00.

MARKET BREAKDOWN
We expected smaller stocks in the S&P 1500 Index to have wider ranges between high and low profit estimates than those of larger stocks — and they did, though the difference between small-cap and large-cap wasn't huge. When we broke the index down into sectors, however, we found massive divergence, with telecom and energy stocks reflecting far more uncertainty than the market while utilities and consumer staples averaged far tighter profit-estimate spreads. Surprisingly, the cyclical industrials and technology sectors averaged spreads the same size or smaller than the typical stock in the index.
Average Estimate
------- Dispersion -------
This Year
(%)
Next Year
(%)
Stock-market value (number of stocks)
Up to $1 billion (262)
16
21
$1 billion to $3 billion (441)
14
19
$3 billion to $10 billion (388)
12
18
$10 billion to $50 billion (307)
13
20
Above $50 billion (101)
13
22
Sector (number of stocks)
Consumer discretionary (252)
12
21
Consumer staples (70)
11
18
Energy (83)
47
56
Financials (212)
10
16
Health care (170)
12
18
Industrials (233)
11
17
Materials (93)
19
24
Real estate (98)
15
20
Technology (221)
11
20
Telecom services (14)
40
41
Utilities (54)
5
9
S&P 1500 Index (1,500)
13
20

For the average stock in the S&P 1500 Index, the spread between the high and low profit estimate for the current fiscal year is 13%. To put that in perspective, picture a stock with a consensus per-share profit target of $1.00, with a high estimate of $1.07 and a low of $0.94. The high and low estimates are separated by $0.13, which is 13% of the consensus.

At the moment, stocks with tight estimate trends are cheaper than those with wide spreads, though they don't look exceptionally cheap relative to the market. Stocks with tight spreads also earn higher scores in Quadrix Momentum, Quality, and Overall.

Estimate spreads vary widely from stock to stock, with sectors such as energy and telecom reflecting far more uncertainty than the broad market.

In the table below, we present A-rated stocks with narrow estimate spreads. Three are reviewed below.

Analysts are getting more excited about technology distributor CDW ($60; CDW). Consensus profit targets for both this year and next year have increased 5% over the last 90 days. Analysts expect sales to rise 5% in both 2017 and 2018, with per-share profits up 12% this year and 9% next year. Such growth shouldn't surprise us, given CDW's history. Over the last three years, CDW grew sales at an annual rate of 9%, while per-share profits rose at a 24% clip.

CDW is working to grow its global footprint, as evidenced by a series of fill-in acquisitions, such as last year's purchase of U.K.-based Kelway. At this point, CDW offers one of the most diversified product selections in its highly fragmented industry, and is approaching a truly global scale. Despite its growth, CDW trades at just 18 times trailing earnings, 21% below the technology-sector median and 11% below its own three-year average. CDW is a Focus List Buy and a Long-Term Buy.


Athletic-shoe retailer Foot Locker ($76; FL) is benefiting from strong consumer demand, especially for its higher-priced products. That demand has limited the need for profitability-crimping price markdowns, boosting sales per square foot of selling space, a key productivity metric for the industry.

In the January quarter, same-store sales rose 5.0%, above analyst expectations. That performance increases our confidence in the company's ability to meet or exceed expectations for the current fiscal year — the consensus projects nearly 6% sales growth and 12% gain in per-share profits. The spread between the high and low profit estimates for this year is just 5%, suggesting most analysts are on the same page.

The sales and profit gains expected this year stand out in part because Foot Locker plans to close more stores than it opens in the year ending January. The broad trend toward active lifestyles, coupled with new products in the basketball, running, and casual footwear lines, should keep the growth on track. Foot Locker is a Buy and a Long-Term Buy.


Synchrony Financial ($36; SYF) has contracted 99% of its credit-card revenue through at least 2019, providing stability that helps explain why the spread between the high and low profit estimates is just 6% for 2017 and 8% for 2018. Analysts expect Synchrony to deliver double-digit profit growth this year, next year, and annually over the next five years. Purchase volumes and balances are rising on a per-card basis, mostly because of improved retailer penetration. Such trends bode well for top-line growth and wider profit margins, both of which are reflected in analyst estimates.

Synchrony, the fifth-largest credit-card issuer in the U.S. and the largest issuer of private-label cards, saw its fraud losses fall 8% last year, while the industry as a whole experienced a rise in fraud losses. Last year, Synchrony financed $125.5 billion in purchases, up more than 10%, while loans receivable rose nearly 12% — trends that make the decline in fraud losses more striking. The company did see a rise in delinquency rates, but its credit quality remains solid.

At 13 times trailing earnings, Synchrony trades at an 11% discount to the median consumer-finance stock in the S&P 1500 Index. Synchrony is a Buy and a Long-Term Buy.

STOCKS WITH ENCOURAGING ESTIMATE TRENDS
All eight of the A-rated stocks below have tighter profit-estimate spreads for this year and next year than the average for their sector. All eight also have flat or rising consensus estimates, with expectations for solid earnings growth this year, next year, and going forward. Stocks on our buy lists are in bold.
Profit-Est.
-- Dispersion --
Estimated Profit Growth
Chg. In Est.,
Last 90 Days
----------- Quadrix Scores -----------
Company (Price; Ticker)
Curr.
Year
(%)
Next
Year
(%)
Curr.
Year
(%)
Next
Year
(%)
Next
5 Yrs.
(Annual.)
(%)
Curr.
Year
(%)
Next
Year
(%)
Earns.
Ests.
Curr.
Year
Next
Year
Overall
Sector
CDW ($60; CDW)
9
12
12
10
8
5
5
88
46
60
96
Technology
Cognizant Technology
($59; CTSH)
4
19
8
17
14
0
6
55
66
46
81
Technology
Foot Locker ($76; FL)
5
8
12
9
10
3
2
89
60
71
96
Cons. discret.
HCA Holdings
($86; HCA)
8
11
7
10
11
4
2
76
50
62
98
Health care
Lincoln National
($69; LNC)
6
7
7
7
8
1
1
37
56
72
88
Financials
PNC Financial
($125; PNC)
8
12
9
12
9
5
6
94
50
60
81
Financials
Synchrony Financial
($36; SYF)
6
8
12
11
11
0
0
44
58
71
91
Financials
UnitedHealth Group
($172; UNH)
3
5
18
12
13
0
0
57
73
78
83
Health care
Notes: Quadrix scores are percentile ranks, with 100 the best.

 


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