Stocks Behaving Badly
Any investor who has read the fine print knows past performance is no guarantee of future returns.
But stocks that have outperformed tend to continue to outperform. While the trend is not absolute, until 2008 it was discernable and beneficial to investors. Our Quadrix Performance score considers a variety of total-return measurements for periods up to one year. Total return reflects capital gains, dividends, and the reinvestment of dividends.
From 1994 through 2007, the Performance score worked quite well, as shown in the chart below. On average, the top one-fifth of Performance scorers in the S&P 1500 Index outperformed the average stock in the index by 1.5% per year.
The last two-plus years have served as a brutal reminder of the old adage about past performance. From 2008 on, stocks with high Performance scores have underperformed dramatically, while those with low Performance scores have massively outperformed.
At some point, we expect the Performance score to regain its effectiveness. Among stocks in the S&P 1500 Index, the score worked for the better part of 13 years before the slide starting in 2008, and the metric has become a bit more effective in the last two months. We can also take some comfort in the fact that price-momentum strategies have worked for more than 80 years, although they tend to generate large swings in performance.
According to one study dating back to 1927, 2009 represented the worst year for momentum investing, generating losses more than triple those of the next worst year. Those numbers suggest the recent poor returns may reflect extreme market conditions rather than a new trend. We expect that going forward, stock-price trends will help us select stocks that outperform.
DirecTV’s ($38; DTV) stock cruised to record highs in March, April, and May. Following a 7% jump over the last month, the shares are up 14% for the year.
DirecTV has embraced 3-D television as a way to differentiate its product. The company is launching four channels in 3-D, including ESPN, and will televise the first Major League Baseball game in 3-D on July 10. Some limitations could hinder widespread adoption — for now, all viewers must own special TVs and wear 3-D glasses — and DirecTV concedes the format will likely work best for animated movies and sporting events.
According to one research firm, nearly 100 million Americans paid for TV service last year, up 3%, and satellite providers are taking share from traditional cable companies. Organic growth has been one DirecTV’s greatest strengths, and management says it has no plans to make content acquisitions or buy a satellite radio service. DirecTV is a Focus List Buy and a Long-Term Buy.
Varian Medical Systems ($53; VAR) doesn’t pay a dividend, so its total return comes exclusively from stock performance. The shares have appreciated at an annualized rate of 8% over the last five years, including 50% in the last 12 months.
One of the largest makers of cancer-diagnostic products and X-ray tubes, Varian is seeing demand pick up in overseas markets. Sales of oncology systems rose 6% in the six months ended March, while X-ray products jumped 13%. Orders for both segments accelerated in the March quarter. In the U.S., modernizing radiation-treatment equipment will likely be a top priority for hospitals once they relax recessionary strictures on capital budgets.
Varian says its new TrueBeam linear accelerator — a device that shoots custom-shaped radiation beams at cancerous tumors — is receiving a lot of interest. The company expects TrueBeam to represent 30% to 50% of new orders for the next several years. Varian Medical is a Focus List Buy and a Long-Term Buy.
Performance score at a glance
• Relatively short-term performance measures of up to 12 months tend to be more effective predictors of stock returns than long-term measures, which is why we don’t consider three- , five- , or 10-year returns for the Performance score. Historically, buying stocks that have lagged over the past three and five years has been a winning strategy.
• The Performance score has never received a big weighting in the calculation of Overall Quadrix scores, but its volatility often makes the Performance score the trigger that keys a sharp move in the Overall score. Of the roughly 4,400 stocks in our Quadrix universe, those earning Performance scores of 80 or higher average Overall scores of 49, implying average fundamentals. Stocks with Overall scores of 80 or higher average a mediocre Performance score of 53.
• In the most recent rally, the high-quality stocks we favor have not led the pack. As such, relatively few of our recommended names earn high Performance scores. For a look at the top Performance scorers in the S&P 1500 Index, visit www.DowTheory.com/go/Perform.