Sometimes Consistency Doesn't Pay

10/12/2009


The theory sounds good.

If a stock routinely beats its benchmark over a period of time, it should be more likely to outperform in the future. However, in this case the theory doesn’t jibe with the facts.

Research by our analysts and many others supports the argument that stocks going up tend to continue going up. Our Quadrix Performance score, which considers a variety of return metrics for periods of up to 12 months, is designed to tap into that phenomenon.

But this week’s cover story takes a different tack. We’re considering whether companies that outperform the S&P 1500 Index consistently for a period of time are likely to outperform in the future.

S&P 1500 Index stocks that have regularly outperformed in the last 12 rolling 12-month periods averaged returns lower than the average stock in the index over the next 12 months. In a back-test of rolling 12-month returns since November 1996, the one-fifth of stocks that outperformed the index most often averaged 12-month returns of 6.6%, versus 8.2% for the average stock and 10.2% for the stocks that underperformed least often.

We see similar trends for stocks coming off longer periods of consistent outperformance, such as three and five
years. In previous research, we’ve seen that stocks with the best three- and five-year trailing returns tend to underperform over the next 12 months.

Does that mean you should go out and buy the worst-performing stocks? Not at all. The effectiveness of the Performance score is warning enough about the danger of bottom-fishing.

But stocks with solid fundamentals that have consistently underperformed are a different story.

Over time, the market generally rewards high-quality companies. With that in mind, the table below lists eight stocks with high Quadrix Overall scores and reasonable valuations that have not received much love on Wall Street. All eight seem capable of market-beating total returns over the next year or two.

UNDERPERFORMERS READY TO POP
All eight of the recommended stocks below earn Quadrix Overall and Quality scores of at least 80, implying solid fundamentals, and trade at a trailing P/E ratio no higher than the industry average. All have lagged the S&P 1500 Index in at least two-thirds of the last 12 rolling 12-month periods.
— Trailing P/E Ratio —
Est.
EPS
Growth,
Next Yr.
(%)
Quadrix Scores *
—— Total Returns ——
Times
OutPer-
formed
S&P 1500,
Last 12
Periods
Company (Price; Ticker)
Current
As %
of 5-Yr.
Avg.
As % of
Industry
Avg.
Quality
Overall
6
Mos.
(%)
12
Mos.
(%)
3 Yrs.
(Ann.)
(%)
Industry
Advice
Energen
($44; EGN)
11
79
79
27
84
91
48
33
4
1
Energy/Utility Hybrids
LT Buy
GameStop
($27; GME)
11
49
97
14
95
83
(9)
(13)
4
1
Electronic Retail
Buy
General Dynamics
($66; GD)
10
66
73
5
92
97
52
4
(2)
3
Aerospace/Defense
Buy †
National Oilwell
($43; NOV)
9
42
68
(14)
97
95
44
33
19
0
Oil & Gas Equip.
Buy †
NII Holdings
($29; NIHD)
16
58
51
16
91
86
123
12
(22)
0
Wireless Telecom
Focus Buy
Precision Castparts
($101; PCP)
14
73
99
6
93
95
67
59
17
5
Aerospace/Defense
Buy †
Stryker
($45; SYK)
16
61
73
11
94
94
35
(21)
(3)
2
Health-Care Equip.
Buy †
Transocean
($86; RIG)
6
30
64
(5)
93
93
37
6
6
1
Oil & Gas Drilling
Focus Buy †
* Quadrix scores are percentile ranks, with 100 the best.      † Also qualifies as a Long-Term Buy.

 


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