Overall And Then Some
In theory, the idea sounds good. The Quadrix Overall score is effective at selecting winning stocks. So is the Value score. So a strategy of buying stocks that score well in both metrics should be even better, right?
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For a list of all stocks in the S&P 1500 Index with Overall and Value scores over 80 as well as a score over 80 in either Momentum or Quality, visit www.DowTheory.com/go/High.
Not necessarily. In a back-test of rolling 12-month returns since 1994, the top quintile, or one-fifth, of the S&P 1500 Index as measured by Overall score outperformed the average stock by 3.0%. In contrast, the top quintile as measured by the sum of the Overall and Value score delivered 2.9% outperformance with substantially more volatility. The top decile, or one-tenth, as measured by Overall and Value together slightly outperformed the top decile of Overall scorers, though again with higher volatility.
However, if you’re looking to add a few stocks to a portfolio, the concept of overlaying different Quadrix scores can pay off. We compared portfolios containing stocks scoring more than 80 or 90 Overall with those containing stocks with similar scores in Overall as well as one or more other Quadrix category scores. Using this methodology, some overlay portfolios delivered superior returns.
Unlike the quintile methodology, which selects the top one-fifth of stocks regardless of absolute Quadrix scores, using a literal score cut-off results in smaller portfolios, as shown in table below. For example, during the tested periods, portfolios containing all S&P 1500 stocks with Overall scores above 90 averaged 138 stocks. Limit the portfolios to stocks with both Overall and Value scores above 90, and the average portfolio size shrinks to 37. Taken to an extreme, portfolios containing only stocks scoring 90 or higher in Overall, Value, and Momentum averaged 11 names.
Based on average outperformance, the portfolios requiring top scores in three categories appear to be the best option. However, in many cases few stocks will qualify. For example, in 33 of our 172 tested periods, fewer than five S&P 1500 stocks earned scores above 90 in Overall, Value, and Momentum. Building a diversified portfolio with such a small number of stocks would be impossible, and restricting yourself to such a small selection universe would severely limit your choices. In the nearby table, we measure volatility using standard deviation, which reflects the dispersion of relative returns.
The table below lists Quadrix triple-threats, recommended stocks that earn scores above 80 in Overall, Value, and either Momentum or Quality. Four are reviewed below:
Over the last five years, Laboratory Corp. of America ($80; LH) averaged growth of 9% for sales and 14% for earnings per share. Despite a 15% rally from February lows, LabCorp trades at 16 times trailing earnings, 6% below the five-year average. Shares also trade at a discount relative to the five-year average for price/sales, price/cash flow, and price/book value.
In the March quarter, LabCorp earned $1.30 per share excluding special charges, up 7% but a penny short of the consensus. Sales advanced 3% to $1.19 billion. Testing volume dipped 3%, hurt by bad weather and the loss of two large government contracts. However, revenue per test rose 6%. Profits should rebound this year. LabCorp’s per-share earnings are expected to climb 12% in 2010 and continue rising at a similar pace for the next five years. LabCorp is a Buy and a Long-Term Buy.
With a Quadrix Overall score of 99, Research In Motion ($72; RIMM) ranks among the top 10% of our research universe in four categories, including a 93 for Momentum and 97 for Quality. The stock trades at 13 times estimated year-ahead earnings, 37% below the three-year average.
As smart-phone competition stiffens in the U.S., RIM could benefit from its presence in foreign markets. Sales outside of North America represented 29% of total revenue in fiscal 2009 ended February but accelerated to 48% in the February quarter. That foreign presence positions RIM well for future growth. While the company’s focus on the low end of the smart-phone market could tighten profit margins, demand for such phones is likely to be much stronger overseas than in North America. RIM is a Buy and a Long-Term Buy.
TJX ($46; TJX) has grown same-store sales by at least 10% in each of the past three months, exceeding Wall Street projections each month. Sales rose 7% in fiscal 2010 ended January, with same-store sales up 6%. Both operating and free cash flow surged in fiscal 2010, rising at least 97%. The off-price retailer has a history of sharing its cash with stockholders.
Over the last three years, the quarterly dividend rose 67%, while the share count declined 4%. TJX plans to repurchase $900 million to $1 billion in stock in 2010, representing about 5% of outstanding shares at the current price. TJX earns an Overall score of 100 and scores above 80 in Momentum, Value, and Quality. The stock, up 26% this year but still reasonably valued at 14 times expected year-ahead earnings, is a Buy and a Long-Term Buy.
Travelers ($53; TRV) grew per-share earnings 20% last year and generated $3.54 billion in free cash flow, up 46%. The insurer used the excess cash to shave 9% off its share count. Over the last three years, Travelers has aggressively repurchased shares, reducing the share count by 24%.
For 2010, Wall Street expects per-share profits to fall 9% to $5.74. One concern is the weather, as March-quarter snowstorms on the East Coast may have triggered more catastrophic claims. Still, Travelers topped consensus profit estimates by at least 22% in the last two quarters, and Wall Street expectations for sales and profits seem conservative. Travelers, slated to declare March-quarter earnings April 23, is a Focus List Buy and a Long-Term Buy.