Value is Still King
Of the six Quadrix® category scores, Value has historically been the best indicator of outperformance. It has also worked very well over the last year.
In the 12 months ended April, the top 20% of stocks in our research universe as measured by Value produced an average return of nearly 69%, versus 56% for all stocks and 46% for the next best category score, Earnings Estimates. Back-tests since 1994 show that top Value scorers averaged 12-month returns of 15.8%, versus 12.3% for the average stock.
Value aside, Quadrix hasn’t worked well over the last year. That isn’t a big surprise, as lower-quality stocks often take the lead in vigorous market rebounds. We expect high-quality stocks to reassert themselves in coming months, partly because they are unusually cheap relative to low-quality stocks. And just as the Value score helped identify outperforming stocks last April, early in the recovery, we expect it to continue pointing us to excellent investments.
Drilling into the Value score
The table below lists the Value factors with the most predictive power in the past year, and since 1994.
Over the last 12 months, the most effective valuation metrics have been price/sales and price/book ratios, both absolute and relative to historical medians. Such statistics tend to be more stable than the price/earnings ratio and typically remain meaningful even when companies post losses. Moreover, at a time when many companies boost profit growth through stock buybacks and cost-cutting measures, investors have emphasized revenue as an important indicator of health.
The table below lists our top 10 value plays and their ranks based on the most reliable Value factors. All 10 earn Value scores above 80 and solid Overall scores. All 10, including the four reviewed in the following paragraphs, also rank above their industry average for both scores.
Advance Auto Parts ($51; AAP) shares rallied 6% the day after it posted 17% per-share-profit growth for the April quarter. But the stock still trades at just 14 times year-ahead estimated earnings.
Advance Auto, the second-largest U.S. auto-parts retailer, operates 3,462 stores in 40 states, Puerto Rico, and the Virgin Islands. It has long focused on do-it-yourselfers but in recent years has pushed into the commercial-mechanic market (33% of sales). The company has captured less than 5% of the $40 billion commercial market, and that market share should rise in coming years.
As the economy finds its legs, Americans continue to seek ways to keep older vehicles running. In addition, many consumers deferred auto maintenance during the recession, leaving a lot of pent-up demand. Both trends should support sales at Advance Auto. Wall Street anticipates 19% higher per-share profits this year, followed by a 12% jump in fiscal 2012 ending January. Advance Auto Parts is a Long-Term Buy.
CVS Caremark ($34; CVS) is slowly dismantling the wall of worry erected last November, when the pharmacy-benefit-management (PBM) segment said it had lost $4.8 billion in 2010 contracts. CVS has announced a handful of new contracts and extensions in recent months, and the company said the 2011 selling season was off to a positive start. Management insisted CVS would not sacrifice profitability to achieve volume gains.
Although the stock has recovered from last fall’s low, the shares trade at less than 15 times trailing earnings, 21% below the five-year average. CVS earns a Value score of 86. The consensus projects 6% per-share-profit growth in 2010 despite an expected 1% dip in sales. Should CVS meet the 2010 estimate and its P/E reverts to the three-year average of nearly 17, the stock would reach $46 per share by the end of the year. While $46 may prove out of reach, a move to $40 or $42 seems achievable.
CEO Thomas Ryan plans to retire in May 2011. His successor will likely be Larry Merlo, head of the retail drug business who currently serves as CVS’ president. CVS is a Focus List Buy and a Long-Term Buy.
Several worries weigh on Hewlett-Packard’s ($46; HPQ) stock, down 11% this year. India claims H-P owes the country $323 million for allegedly skirting customs duties by underpricing imports. The company remains under investigation by Germany, Russia, and the U.S. for possibly bribing officials in 2003. Finally, Europe’s economic woes represent a threat to H-P, as about one-fourth of its revenue is denominated in euros.
H-P hopes to complete its Palm ($6; PALM) acquisition in the July quarter. The $1.2 billion cash acquisition plants H-P in the middle of the smart-phone battlefield. By supplying both the operating system and the hardware, H-P hopes to emulate formulas used successfully by Apple ($245; AAPL) and Research In Motion ($59; RIMM). Rival smart-phone makers enjoy a big head start, but H-P can afford to chase market share by sacrificing profit margins, buoyed by its other, far larger, business segments.
Within the more established personal-computer market, recent share gains give H-P a bigger piece of the rebound in technology spending. Trading at 14 times trailing earnings, 11% below the five-year average, H-P is a Buy and Long-Term Buy.
Raytheon ($52; RTN) earns a Value score of 91. The stock trades at 10 times estimated year-ahead earnings, 25% below the five-year average forward P/E ratio.
U.S. Defense Secretary Robert Gates’ promise to impose fiscal discipline on the military’s bloated budget has pressured defense stocks. Attracting most of Gates’ attention have been bulky programs that fund pricey fighter jets and warships, as well as the military’s bloated bureaucracy and soaring health-care costs.
Raytheon got nicked when the U.S. Army canceled an attack-missile program after it was 90% through the $1 billion developmental phase, missing out on a potentially much larger production contract. However, Raytheon’s focus on versatile and high-tech products — missile systems, surveillance gear, and infrared sensors — should insulate the company from the worst of the defense cuts.
Broad product lines and geographic diversity provide additional protection against U.S. budget cuts. None of Raytheon’s six business segments accounts for more than 21% of total sales, and the company collects more than one-fifth of its revenue from international clients. Raytheon is a Focus List Buy and a Long-Term Buy.