We Want More Than Just Value

10/16/2017


You won't find a lot of super-cheap stocks on our Focus List, or on any of our other buy lists.

Don't chalk that up to a dislike of value stocks; we always appreciate appealing values. However, valuation alone never qualifies a stock for the Focus List. Because we also require some measure of growth, as well as the potential to outperform expectations, the very cheapest stocks in the market rarely end up as Buys. Of course, you'll have an equally tough time finding the very strongest growers on our recommended lists, because they often trade at far too high a valuation to tempt us.

Our Quadrix stock-rating system tends to lead us to high-quality stocks that look good from a number of angles, avoiding stocks that excel solely on growth, or solely on value.

With stock valuations unusually high (see the story below for more), today we screened through our Focus List in search of the best values. Three are profiled in the following paragraphs. A fourth, ON Semiconductor ($19; ON), is presented in Portfolio Review, and a fifth, Owens Corning ($80; OC) is featured in Analysts' Choice:

Managed-care provider Centene ($96; CNC) has returned 33% over the last six months, helped in part by the market's gradual realization that the Trump administration would not be able to repeal — or even scale back — the Affordable Care Act this year. While larger insurers back away from the federal insurance exchanges, Centene is expanding its presence. Unlike many of its peers, Centene generates solid results from its exchange operations.

Despite its strong share-price action, Centene trades at 19 times trailing earnings, roughly in line with its industry median and 9% below its own three-year average P/E ratio. Centene's consistent growth (26 quarters of at least 9% sales gains), rising profit estimates (2017 and 2018 analyst profit targets up at least 2% over the last three months), and ability to grab market share as rivals pull in their horns bode well for near-term operating results. Analysts expect the Focus List Buy and Long-Term Buy to grow per-share earnings 11% both this year and next year.  


Citizens Financial Group (37; CFG) trades at 16 times earnings over the last 12 months and 13 times expected 2018 earnings, representing respective discounts of 14% and 16% versus the median regional bank in the S&P 1500 Index. In the first half of this year, Citizens grew average loans 7% and average deposits more than 15%. In the June quarter, Citizens' net interest margin (the spread between what the bank collects on loans and pays out on deposits) rose to 2.97% from 2.85% in the year-earlier period.

Couple the bank's growth and profitability trends with increasing yields on loans and improving credit quality, and you have a company that seems capable of topping the consensus earnings-growth target of 17% for the second half of 2017 and 10% for 2018. Citizens, yielding 1.9%, is a Focus List Buy and a Long-Term Buy.


Auto-parts maker Lear ($173; LEA) earns a Quadrix Value score of 91, which reflects scores in the top one-fifth of our research universe for price/earnings on current- and next-year estimates, price/sales, enterprise ratio, and price/earnings-to-growth (PEG) ratios. The stock trades at a discount of at least 25% to its peer group on trailing price/earnings, price/sales, price/operating cash flow, and enterprise value.

While Lear may be valued like a company with no operating momentum, it has topped 7% sales growth and 30% per-share-profit growth in each of the last two quarters. Stronger sales of cars in China and Europe should offset an expected decline in U.S. auto sales this year — though the hurricanes in Texas and Florida have boosted demand for new cars to replace totaled vehicles. Lear, which yields 1.2%, is a Focus List Buy and a Long-Term Buy.

OUR FOCUS LIST
Only five of the stocks on our Focus List trade flat or lower than their industry average for price/earnings, price/book, and price/sales ratios. All five earn Quadrix Value scores of 72 or higher, and we profile three of them starting on page 1. The median Focus List stock trades at a discount of 13% to its industry average P/E ratio, but looks in line with the typical stock on price/book ratio and trades at a premium on price/sales. Why aren't they all cheap? Because we seek growth at a good price, not just a good price.
Total Return
---- P/E Ratio ----
Price/Book Ratio
Price/Sales Ratio
Quadrix Scores
Company (Price; Ticker)
Div.
Yield
(%)
3
Months
(%)
YTD
(%)
Trailing
Premium
(Discount)
To Industry
Average
(%)
Trailing
Premium
(Discount)
To Industry
Average
(%)
Trailing
Premium
(Discount)
To Industry
Average
(%)
Value
Overall
Industry
Alphabet
($1,006; GOOGL)
0.0
5
26
27
(7)
4.8
19
7.1
79
40
80
Internet
software
CDW ($69; CDW)
0.9
11
36
19
(16)
12.9
315
0.8
(62)
57
77
Electronic equip.
Celgene
($140; CELG)
0.0
6
21
21
(36)
13.4
148
9.3
61
50
92
Biotechnology
Centene ($96; CNC)
0.0
18
71
19
(5)
2.7
(14)
0.4
(68)
84
97
Health
providers
Chemours ($55; CC)
0.2
32
149
24
(4)
18.6
331
1.8
(7)
70
96
Chemicals
Citizens Financial
($37; CFG)
1.9
3
7
16
(12)
1.0
(43)
3.1
(30)
88
99
Banks
Comcast
($37; CMCSa)
1.7
(2)
11
19
(3)
3.3
(10)
2.1
31
76
90
Media
Facebook ($173; FB)
0.0
11
49
33
17
7.7
93
15.4
290
34
90
Internet
software
ICON ($116; ICLR)
0.0
15
52
23
(24)
6.1
25
3.7
(14)
41
92
Life sciences
Lam Research
($186; LRCX)
1.0
21
76
19
(19)
5.1
29
4.3
15
66
99
Semiconductors
Lear ($173; LEA)
1.2
17
32
11
(25)
3.3
(1)
0.6
(56)
91
100
Auto
components
ON Semiconductor
($19; ON)
0.0
34
52
19
(16)
3.9
0
1.7
(56)
80
99
Semiconductors
Owens Corning
($80; OC)
1.0
22
55
21
(13)
2.3
(47)
1.5
(24)
72
95
Building
products
VMware
($112; VMW)
0.0
26
42
33
(4)
5.4
(13)
6.2
19
50
94
Software
Focus List median
0.1
16
46
20
(13)
4.9
60
2.6
(11)
68
95
NM  Not meaningful because of a lack of historical data.   Notes: Quadrix scores are percentile ranks, with 100 the best.   Industry and sector averages exclude some outliers.

In search of the elusive value

In today's market, value has become difficult to find. At least, it's tough if you focus on absolute numbers.

The average S&P 1500 Index stock trades at 25.1 times trailing earnings, 17% above the norm of 21.4 since 1994. Today's average P/E ratio is higher than all but three of the 274 month-end valuations since 1994.

Given the P/E trend, it should come as no surprise that more than two-thirds of stocks in the index trade above their five-year average price/earnings ratio. Values relative to historical norms are in particularly short supply — which helps illustrate the usefulness of our Quadrix Value score.

Whether the average stock trades at 24 or 18 times earnings, the middle P/E ratio will earn a Quadrix rank of 50. Same with all the other Quadrix statistics. Just as the average P/E ratio changes over time, so do the characteristics of a stock that earns a 50 in Value. We designed Quadrix to rank each stock relative to about 5,000 others — based on what they look like today.

At the end of September, a trailing P/E ratio of 20.9 earned a Quadrix Value score of 50, well above the norm of 17.3 since 1990. In fact, only four of the last 333 months have seen a Quadrix score of 50 in P/E equate to a higher P/E ratio than 20.9. All four of those pricey months came this year.This disparity over time inspires us to make three points:

1) Quadrix seeks the strongest stocks today, ranking them relative to the rest of the current market. But Quadrix does not compare them to the broad historical universe. While a stock with a Value score of 100 today may not be as cheap on an absolute basis as one that earned a similar score five years ago, it's still among the cheapest available now, when you can actually buy it.

2) Even when using Quadrix, we can't ignore absolute values. A P/E ratio of 20 is pricier than a P/E ratio of 16, even if market conditions earn the P/E of 20 a Quadrix score similar to that earned by the P/E of 16 during its time. Does that mean we should disregard Value scores when the market gets expensive? Not at all. But there's a reason we discuss the market's broad valuation frequently in our Market Commentaries. When valuations get stretched, we often see a greater risk of a marketwide correction, which will probably affect most stocks, even those with high Quadrix scores.

3) While the Quadrix Value score has the best long-term performance record of the six category scores, investors shouldn't rely solely on it. No quantitative system, no matter how well-designed, takes the same snapshot of the market all the time. And sometimes, for whatever reason, the Value score doesn't work. Not surprisingly, during those periods, other category scores tend to see increased predictive power.

The Quadrix Overall score takes into account about 100 individual statistics reflecting a variety of aspects of each stock and, regardless of market conditions, provides you with our best quantitative assessment of how an individual stock stacks up against the rest.


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