Don't Settle For Merely Good

3/22/2010


Stocks with Quadrix® Overall scores in the top one-fifth of our research universe tend to make good investments. But our research suggests that the very highest scorers tend to do even better.

For example, in a back-test to 1994, the S&P 1500 Index stocks with Overall scores in the top 20% averaged 12-month returns of 14.7% (3.1% above the 11.6% return of the average stock in the index). The top 5% averaged 17.7% returns, and those in the top 2% returned 19.2%. That trend holds true with most Quadrix category scores, as well as most individual factors.

Our Quadrix stock-rating system assigns more than 4,000 U.S.-traded stocks percentile ranks based on dozens of variables. The stock that scores best in a given metric earns the highest Quadrix rank of 100, while the worst earns a 0. Stocks that earn Overall scores in the top 20% tend to have solid fundamentals, as a company cannot earn a high Overall score unless it earns fairly high scores in a number of variables. But to rank in the top 5% or 2% as measured by Overall score, a company typically needs to score well in a lot of areas.

In the table below, we present the average returns of top scorers in Overall, and in all six Quadrix category scores. For all but Earnings Estimates, the very highest scorers delivered the strongest performance. The Financial Strength, Quality, and Performance scores in particular become much more effective when you look at only top scorers, with the outperformance of stocks in the top 2% relative to the average at least eight times as large as the outperformance for the top 20%.

TAKING QUADRIX TO THE EXTREME

Below, we present performance data for top Quadrix scorers in the S&P 1500 Index. For example, in a back-test of 12-month returns since 1994, the top 2% of the S&P 1500 Index as measured by Overall score returned 19.2%, outperforming the average stock’s return of 11.6% by an average of 7.6%. In contrast, the top 20% of Overall scorers averaged 3.1% outperformance.

For all category scores except Earnings Estimates, the very top scorers delivered stronger outperformance than portfolios including stocks with somewhat lower — though still high — scores. Relative to the performance of the top 20%, the top 2% of scorers for Performance, Momentum, Financial Strength, and Quality scores were particularly effective. Standard deviation measures the volatility of 12-month returns, with roughly two-thirds of 12-month returns within one standard deviation of the average return.

Top 2% Of
— S&P 1500 —
Top 5% Of
— S&P 1500 —
Top 20% Of
— S&P 1500 —
Avg.
12-Mo.
Perfor-
mance
(%)
Stan-
dard
Devi-
ation
(%)
Avg.
12-Mo.
Perfor-
mance
(%)
Stan-
dard
Devi-
ation
(%)
Avg.
12-Mo.
Perfor-
mance
(%)
Stan-
dard
Devi-
ation
(%)
Quadrix Category Scores
Overall
19.2
26.4
17.7
24.7
14.7
21.0
Value
18.8
40.0
17.6
33.7
14.8
26.8
Quality
17.6
28.8
14.8
26.2
12.3
21.1
Financial Strength
15.0
28.1
12.4
23.1
11.9
18.9
Momentum
14.5
27.2
12.8
25.3
12.4
21.7
Performance
14.2
36.3
12.9
30.5
11.6
21.5
Earnings Estimates *
2.9
26.5
4.0
24.6
4.4
22.2
Individual Factors (Category)
Enterprise Value/EBITDA
(Value)
23.5
30.3
20.3
27.2
16.3
24.4
Price/Sales To 5-Yr.
Median (Value)
23.5
55.3
19.3
45.8
15.3
32.0
Price/Book To 5-Yr.
Median (Value)
22.3
54.0
17.6
43.8
13.5
31.1
Price/Book Ratio (Value)
21.9
54.9
19.1
45.2
15.4
30.8
Price/Cash Flow To 5-Yr.
Med. (Value)
21.6
39.3
17.5
32.7
13.8
24.8
5-Yr. Sales Growth
(Quality)
20.1
39.6
17.5
31.2
13.3
23.5
Price/Sales Ratio (Value)
20.1
50.5
18.1
40.8
14.8
29.8
Price/Earnings Ratio
(Value)
19.9
40.5
18.6
33.5
14.6
25.7
Price/Cash Flow To 3-Yr.
Med. (Value)
19.2
38.6
16.5
32.3
13.3
25.2
Price/Free Cash Flow
Ratio (Value)
18.8
38.3
18.1
32.8
15.8
25.8
Price/Sales To 3-Yr.
Median (Value)
18.6
54.6
16.7
46.8
14.3
32.4
Price/Earnings To 3-Yr.
Median (Value)
16.6
33.2
14.0
28.6
12.2
23.8
Price/Earnings To 5-Yr.
Median (Value)
15.7
32.4
14.9
28.5
13.0
23.7
2-Mo. Total Return
(Performance)
15.2
36.8
13.4
30.4
11.9
22.4
3-Yr. Sales Growth
(Quality)
15.2
39.1
13.0
29.6
11.9
23.0
3-Mo. Total Return
(Performance)
14.8
35.6
13.6
30.9
12.0
22.6
Interest Coverage Ratio
(Fin’l Strength)
14.4
25.1
12.7
22.7
11.0
20.1
Operating Profit Margin
(Fin’l Strength)
14.2
25.6
13.7
21.2
11.8
19.4
6-Mo. Total Return (Value)
14.1
36.1
13.5
31.1
12.1
22.4
Op. Margin Before Deprec.
(Fin’l Strgth)
14.0
25.4
13.3
21.7
11.5
19.7
* Data for Earnings Estimates score since 2004.    

The table also provides data on 20 individual Quadrix statistics that work particularly well for the very best scorers. Given the effectiveness of the Value score, it is no surprise that valuation metrics comprise 12 of the 20 stats. However, the list also includes three factors for the Financial Strength score, historically one of the least-effective category scores.

In the following paragraphs, we review two off-price retailers, both of which earn extremely high Overall scores and also score well in several of the most effective individual factors.

Ross Stores’ ($54; ROST) 1,005 locations are for bargain hunters. The same could be said of its stock, which trades at 14 times estimated year-ahead earnings, 21% below the retail-industry
average.

The discounter owes much of its success to off-price buying. This strategy involves purchasing merchandise later in the buying cycle, taking advantage of production overruns and orders canceled by other retailers. Off-price buying puts more variables in motion — the timing, quality, and quantity of inventory hitting the shelves becomes less predictable. This also means discounts for shoppers pinched by the sluggish economy yet still seeking stylish apparel.

From an operational standpoint, Ross is topping its peers. Over the last year, specialty retailers in the S&P 1500 Index averaged 3% lower sales, but Ross grew revenue 9%. The consensus projects per-share-profit growth of 10% for the year ending January 2011 and annualized growth of 15% over the next five years.

Ross was slated to report January-quarter earnings on March 18, one day after the Forecasts went to press. Wall Street expected earnings of $1.16 per share, implying 53% growth, on 13% higher sales. Ross is a Focus List Buy and a Long-Term Buy.


Discount retailer TJX ($43; TJX) scores at least 80 in five of the six Quadrix categories. The lone exception is Performance (58), but the shares have posted an 18% total return over the past two months, quadruple the median return of stocks in the S&P 1500. Strong operating momentum is one reason for the recent gains. In the first two months of 2010, TJX reported double-digit growth in same-store sales, topping consensus expectations both months.

With its base of older stores flourishing, TJX now plans to accelerate expansion efforts. Management expects to open 130 new stores this year, on top of 91 new stores launched in fiscal 2010 ended January. TJX says in the spring of 2011 it will introduce a new concept store that could potentially turn into a 100-store chain. Ultimately, TJX sees its store count for established chains climbing by roughly 50% within current markets. Considering the company’s concept plans and its push across Europe, TJX’s eventual growth could exceed that target.

About 80% of TJX’s stores are located in the U.S. The remaining stores are split between Canada and Europe, where some of the most attractive growth opportunities lie. TJX opened its first stores in the United Kingdom in 1994 and spread to Ireland, Germany, and now Poland. Costs associated with new European stores are about double those of their U.S. counterparts, but population density also makes the stores far more productive. And more stores could bolster margins as TJX leverages economies of scale. Trading at less than 14 times estimated year-ahead earnings, TJX is a Buy and a Long-Term Buy.

TIP OF THE TOP
The six recommended stocks listed below fall in the top 5% of our research universe as measured by Quadrix Overall score. All six earn at least 70 in four or more of the six category scores.
—————————— Quadrix Scores * ——————————
Company (Price; Ticker)
Div.
($)
Yield
(%)
Trailing
P/E Ratio
Est.
Curr.-
Yr. EPS
Est.
(%)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
Industry
Aflac ($54; AFL)
1.12
2.1
11
10
88
92
84
82
77
83
99
Insurance
AmerisourceBergen
($28; ABC)
0.32
1.1
15
20
84
81
89
52
80
71
96
Health Care
Research In Motion
($75; RIMM)
0.00
0.0
19
29
95
70
100
97
65
47
98
Commun. Equip.
Ross Stores ($54; ROST)
0.64
1.2
17
52
91
74
98
88
83
59
98
Specialty Retail
TJX ($43; TJX)
0.48
1.1
15
12
88
80
94
81
92
58
98
Specialty Retail
Travelers ($53; TRV)
1.32
2.5
8
-8
95
94
79
88
45
41
96
Insurance
* Quadrix scores are percentile ranks, with 100 the best.

 


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