Never too late to add Quadrix

5/19/2008


We start our stock analysis with Quadrix.

We realize that many of you do not. But even if you start somewhere else — valuation, growth, relative strength, yield, etc. — Quadrix® can help you find the best stocks.

Why do we use Quadrix to help us pick stocks? Because it works. High Overall scorers tend to outperform middling and low scorers. But while Quadrix is designed to help investors separate the wheat from the chaff as a first screen, it can also add value as a second screen. To illustrate this ability, we tested Quadrix on stocks with low P/E ratios, high three-month returns, high dividend yields, or strong five-year dividend growth. Quadrix leaders outperformed in all four selection pools.

In a back-test of 12-month stock returns since March 1995, the top one-fifth of stocks in the S&P 1500 Index as measured by price/earnings ratio or three-month relative strength outperformed the average stock in the index. The outperformance of both value and momentum stocks is not big news — plenty of research has shown that such strategies work. Of greater interest is the fact that narrowing the field with Quadrix can augment returns.

One-fifth of stocks with the lowest P/E ratios averaged 12-month returns of 16.7%. By screening further to eliminate all stocks with Quadrix Overall scores below 50, the average return rises to 17.3%. Limit your portfolio to stocks with Overall scores of 80 or more, and the average return jumps to 20.4%. The same trend holds true with the three other strategies we tested.

Interestingly, Quadrix also helped improve the performance of strategies that lagged the market. The top-yielding stocks and those in the top quintile as measured by five-year dividend growth actually notched returns below those of the average stock. But by adding a second screen that isolated the top Quadrix Overall scorers among those high-yielders or dividend growers, we managed to boost returns above the average stock’s performance.

Three recommended stocks that would come up in at least one of the screens discussed above, and that also earn high Quadrix Overall scores are reviewed in the following paragraphs.

While news headlines tend to focus on the shock-and-awe aspects of military contracts — missile systems, fighter jets, and tactical vehicles — just as crucial to the military are the communication systems that Harris ($59; NYSE: HRS) provides. In April, Gen. David Petraeus told the Military Times that intelligence, surveillance, and reconnaissance capabilities were at the top of the military’s wish list. But, he added, bandwidth and frequency constraints and tactical issues make it difficult to provide those capabilities to the commanders who need them. Harris has profited handsomely by solving that problem and supplying the military’s desire for advanced communications systems.

The never-ending quest for better communications is partly responsible for the strong results of Harris’ defense-communications business. The Falcon II and Falcon III tactical radios have become standard equipment on the new mine-resistant ambush-protected vehicles being deployed in the Middle East. Harris expects orders in the fiscal year ending June to substantially exceed revenue. On May 13, the U.S. Marine Corps ordered up to $350 million in radios. The defense-communications unit’s sales rose 22% in the March quarter and 18% in the nine months ended March.

Harris shares jumped May 9 on newspaper reports that it is considering “strategic options,” including the potential sale of the company. Harris has not commented on the rumors, but its product portfolio could appeal to many large defense contractors. The stock has attractive upside potential even without a takeover, and Harris remains a Focus List Buy and a Long-Term Buy.


Two Lockheed Martin ($109; NYSE: LMT) airplane programs appear ready to help fuel the company’s profit growth over the next several years. The defense contractor is ramping up its production of the C-130J Super Hercules tactical airlifter to meet increased U.S. and international demand. In recent months, Norway, Canada, and India have ordered C-130Js, expanding a customer list that already included Australia, Denmark, Italy, and the U.K. The company plans to jack up its production to 24 planes a year by about 2011, double the current production rate. The additional sales could boost annual revenue by roughly $300 million.

The F-35 fighter jet is a longer-term revenue source. The first test flight occurred in December 2006. Deliveries are slated to begin in 2010, continuing through at least 2030. In April, the Pentagon placed a $2.4 billion order for 12 jets. By 2015, the F-35 program could account for more than $15 billion in annual revenue. Several U.S. allies are also considering the F-35, which looks even more attractive now, with the dollar low relative to many foreign currencies.

News reports suggest Lockheed is likely to win a contract worth at least $1.8 billion to build next-generation satellites. The contract could be worth more than $4 billion. At 14 times expected year-ahead earnings, Lockheed trades at a discount to the average forward P/E ratio of nearly 16 for defense stocks. Lockheed Martin is a Focus List Buy and a Long-Term Buy.


The Social Security system may be in trouble as Baby Boomers get ready to retire, but the impending retirement of those 78 million people — and concerns about the collapse of the government safety net — gives MetLife ($61; NYSE: MET) an opportunity. Of the company’s 7 million clients, about 2 million are close to retirement. Most of MetLife’s retirement-ready clients do not currently own an annuity, and the company focuses its sales efforts on this group. People who will retire in the next few years expect to live well past age 65. Many will need to build up retirement portfolios that last as long as 30 years.

MetLife’s annuity products have boosted the bottom line in recent years. Providing 19% of operating earnings in 2007, annuities represent the most profitable part of the company’s offerings for individuals. Between 2002 and 2007, earnings from annuity premiums and fees have grown at an annualized rate of 37%.

Turmoil in equity markets has hurt the variable-annuity market in recent months. MetLife’s variable-annuity deposits fell 4% in the March quarter from the year-earlier period, performance considerably better than the industry average of a 10% decline. MetLife is a Buy and a Long-Term Buy.

 


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