Look For High-Performance Names

7/27/2009


Stocks that go up tend to continue going up.

While that statement may seem counterintuitive to investors who have been advised to look for bargains, history has shown it is true. Stocks with high Quadrix® Performance scores tend to outperform the average stock over the next three and 12 months. The Performance score considers a stock’s trailing total returns over a variety of periods of up to one year.

The top one-fifth of S&P 1500 Index stocks as measured by Performance score averaged 12-month returns of 12.2% since 1994, versus 10.7% for the average of all S&P 1500 stocks. And while the Quadrix system was not designed to pick three-month winners, the Performance score has also proved effective for the shorter time period.

While the Performance score is an effective predictor of stock performance, price action alone is not enough reason to buy a stock. The Overall score — which takes into account the Performance score as well as scores for Value, Momentum, Quality, Financial Strength, and Earnings Estimates — works even better.

Investors looking for timely picks should consider stocks with solid Performance scores. But limit the field to companies with strong fundamentals — stick with those that also earn solid Overall scores, like those listed in the table below and reviewed below.

Hospira ($37; HSP) makes and distributes more than 200 generic injectable drugs, accounting for roughly half the company’s sales. The stock has surged 39% since the start of this year, helped by an increased interest in generic biotechnology drugs, known as biosimilars. President Obama’s mandate to cut health-care costs has put pressure on Congress, which in turn seeks alternatives to costly biotech drugs.

Far more complex than traditional compounds, biotech drugs are created using biological organisms. Biosimilars, allowed in Europe but not the U.S., nearly match the proteins used in biotech drugs. Patent protection remains a point of contention, and different proposals call for as few as five years of exclusivity and as many as 14 years. Regardless of the final decision on patents, Hospira — which already sells biosimilars in Europe — stands to benefit if the U.S. begins allowing biosimilars.

Wall Street anticipates per-share profits will climb 5% this year on cost savings from restructuring and 14% in 2010 as sales growth resumes. Hospira is a Focus List Buy.


Microsoft ($25; MSFT) ranks among the top 26% of companies in our research universe as measured by Performance score. The stock has jumped 63% from its March low, and historical valuation ratios suggest it still has room to run. Shares trade at 14 times trailing earnings, below the three-year average of 16.

In the first month after the May introduction of new search engine Bing, Microsoft’s share of the U.S. search market share rose to 8.4% from 8.0%. Microsoft still trails Google’s ($428; GOOG) 65% share and Yahoo’s ($17; YHOO) 20%. But the new search engine offers innovative features, such as letting users preview text or video before visiting sites. During Bing’s first month, Microsoft’s “paid clicks,” or the number of times users clicked on advertisements from which Microsoft collects a fee per click, jumped 80%. Even if Bing doesn’t make huge market-share inroads, it could substantially boost Internet revenue.

While the Internet wars are fun to watch, the Windows operating system and Office business software still combine to generate about 87% of Microsoft’s profits. The latest iteration of Windows launches later this year, with a new version of Office slated for release in the first half of next year. Microsoft is rated a Long-Term Buy.


Geographic diversity, a broad product portfolio, and a steady stream of maintenance revenue fuel Oracle’s ($22; ORCL) growth engine. The developer of databases and other business software is also counting on the $7.4 billion takeover of Sun Microsystems ($9; JAVA) to boost profits by at least $1.5 billion in the first year after the deal, which is expected to close this summer.

Oracle calls Sun’s programming language Java “the single most important software asset we have ever acquired.” Java, used to write many of the world’s business programs, runs on 800 million personal computers and 2.1 billion cell phones. Oracle will collect royalties from manufacturers and developers that use Java. Moreover, Oracle will use Java to improve compatibility within its own software portfolio, which is jumbled after more than 50 acquisitions since 2005.

The stock has bounced 57% from March lows but still seems reasonably valued at 14 times projected year-ahead earnings. The consensus per-share-profit estimate for fiscal 2010 ending May has risen by $0.04 to $1.53 over the last month and now projects per-share-profit growth of 6% — a target that still seems low. Oracle is a Buy and Long-Term Buy.


Precision Castparts ($77; PCP) operates massive machinery that creates products ranging from titanium bulkheads to nickel airfoils. Exposure to Boeing ($43; BA) and Airbus leaves Precision vulnerable to production delays. In June, Boeing pushed back delivery of its troubled 787 Dreamliner once again. The order backlog for the 787 has dropped 7% this year, but most carriers seem willing to wait for the fuel-efficient Dreamliner. Predictably, Precision’s shares reeled on news of the delay.

In the June quarter, Precision’s per-share earnings fell 13% to $1.70, $0.05 below the consensus. Revenue fell 24%, but the company was able to boost profit margins with cost reductions and productivity gains. Inventory destocking among its aerospace customers will weigh on September-quarter results, but the company expects improved demand in the December and March quarters. Consensus estimates project per-share earnings of $7.44 for fiscal 2010 ending March and $7.64 for fiscal 2011, but the company seems capable of exceeding the fiscal 2011 forecast. Precision Castparts is a Long-Term Buy.

PERFORMANCE LEADERS
All eight of the recommended stocks below earn Quadrix Performance scores above 60 and have outperformed the S&P 1500 Index over the last three, six, and 12 months.
— Stock-Price Change —
– Quadrix Scores * –
Company (Price; Ticker)
Market
Value
($Mil.)
3
Mos.
(%)
6
Mos.
(%)
12
Mos.
(%)

Div.
Yield
(%)

Trailing
P/E
Ratio
Perfor-
mance
Overall
Industry
Advice
AstraZeneca
($46; AZN) e
67,102
35
20
1
4.4
9
71
98
Pharmaceuticals
Buy †
Cognizant Tech.
($29; CTSH)
8,530
29
53
4
0.0
20
80
97
IT Consulting
Focus
Buy †
Hospira ($37; HSP)
5,976
17
50
(1)
0.0
14
81
92
Health-Care Equip.
Focus
Buy
Microsoft ($25; MSFT)
220,980
31
34
(3)
2.1
14
74
83
Systems Software
LT Buy
Oracle ($22; ORCL)
109,809
12
36
4
0.9
15
75
96
Systems Software
Buy †
Precision Castparts
($77; PCP)
10,847
22
33
(25)
0.0
10
62
92
Aerospace/Defense
Buy †
Qualcomm
($48; QCOM)
79,408
19
41
6
1.4
25
74
67
Commun. Equip.
LT Buy
Sigma-Aldrich
($50; SIAL)
6,114
27
37
(14)
1.2
19
68
83
Specialty Chemicals
LT Buy
† Also qualifies as a Long-Term Buy.      * Quadrix scores are percentile ranks, with 100 the best.      e Dividend and yield estimated.


Performance scores at a glance

Just as stock returns are volatile, so is the Quadrix® Performance score. Do not be surprised if a stock that earned a 60 last week earns an 80 this week.

Like all Quadrix scores, Performance scores rank stocks relative to other stocks. Over the past 12 months, the average S&P 1500 stock fell 22%. Given that
backdrop, a stock need not have rallied in all the periods measured to earn a high Performance score. 

Because shares of weak companies have performed best since March, our Buy List includes a smaller-than-normal number of stocks with high Performance scores. All else equal, we prefer to recommend stocks with above-average Performance scores. But we won’t chase low-quality stocks based solely on share-price action. Stocks with high Performance scores have not kept pace with the average stock since March, so our lack of exposure to Performance standouts has not crimped the recent returns of our Buy List. On a fully invested basis, our Buy List has gained 13.0% in 2009, versus 14.5% for our Focus List, 11.5% for our Long-Term Buy List, and 5.7% for the S&P 500 Index.


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