Seeking Momentum And Quality

1/24/2011


Over long periods of time, Value has been the Quadrix® category score most effective at identifying winning stocks. But in the second half of 2010, stocks with strong operating momentum delivered better returns.

In three of the last four months, the top one-fifth of the Dow Jones U.S. Index as measured by either Momentum or Quality score outperformed the average stock in the index. During that four-month period, a strategy of buying the top Momentum scorers at the end of the month, holding them for a month, and then rebalancing outperformed the average for all stocks by 4.2%. Quality leaders outperformed by 1.2%.

The Momentum score reflects short-term growth rates, while the Quality score considers long-term growth and returns on equity, investment, and assets. Both scores tend to perform well at the same time, as they favor high-quality companies with operating momentum.

Historically, these stocks have tended to show strength during periods when investors are a bit worried, and thus seek companies capable of riding out a storm.

Both Momentum and Quality leaders lagged in December, as did the Overall score and all Quadrix category scores other than Value. In December, optimism spread and riskier stocks performed well. The underperformance of Quadrix in December should not surprise us, as stocks with fundamental strength aren't usually the first ones to rise when investors' appetite for risk increases.

Will stocks with high Momentum or Quality scores set the pace for the rest of the year? We can't predict that. But given concerns about continued slow growth — as well as the risk of a near-term stock-market correction — owning stocks with operating momentum and a solid growth history makes sense.

Where can you find these stocks? Start by thinking big. The 50 largest stocks in the S&P 500 Index average Momentum scores of 61 and Quality scores of 71, well above the averages for the index. From another angle, technology is the only sector with average Momentum and Quality scores above the average for the S&P 1500. The energy and industrials sectors also look pretty good as measured by those scores.

Check out the table below, which contains 16 A-rated stocks with strong Momentum and Quality scores. Three are reviewed below.

Railroad giant CSX ($69; CSX) has a strong track record for growing per-share earnings (five-year annualized growth rate of 25%) and dividends (35%). The Momentum score of 81 — up from 23 a year ago — reflects recent gains in operating cash flow (up 17% in the 12 months ended September) and sales (up 8%). CSX has also expanded its operating profit margins by squeezing higher prices from customers. Despite those higher prices, volumes rose 9% in 2010, supported by the rebound in the automobile industry.

Rising profit estimates suggest CSX's operating momentum is sustainable. Wall Street projects December-quarter profits of $1.09 per share, up 42%, on 15% higher revenue. Results are slated for release Jan. 24.

For 2011, Wall Street expects CSX to grow per-share profits 18% on 7% higher sales. In September, CSX raised its quarterly dividend 8% to $0.26 per share, marking the eighth increase in the last five years. CSX, yielding 1.5%, is a Focus List Buy and Long-Term Buy.


Newmont Mining ($57; NEM), the second-largest gold producer in the world, operates on five continents. Shares move with the price of gold bullion, and though the stock trades within 14% of the all-time high set in September, Newmont's valuation is still compelling. The stock trades at 15 times trailing earnings, a 34% discount to its three-year average price/earnings ratio.

The stock's recent Quadrix history is also worth noting. Neither its Quality nor Momentum score has ended a month below 88 since March. Sales have shown impressive growth (up 35% in the nine months ended September and up an annualized 17% over the past five years), as have per-share profits (up 79% and 31%) and operating cash flow (up 19% and 20%).

The company should continue to benefit from its revitalized base of gold and copper reserves, and also from more than two dozen new projects flowing through the pipeline. Newmont, yielding 1.1%, is a Focus List Buy and a Long-Term Buy.


In each of the last four quarters, Texas Instruments ($35; TXN) has reported growth of at least 20% for sales and 65% for per-share profits. In that stretch, cash provided by operations surged 30% to $3.59 billion. In the last two quarters, returns on equity, assets, and investment have exceeded prerecession levels. Shares have soared 51% since August, more than doubling the 23% gain posted by the S&P 500 Index. But at 15 times trailing earnings, the stock trades 19% below its five-year average P/E ratio and 16% below the average semiconductor stock in the S&P 1500 Index.

In December, Texas Instruments narrowed its guidance for the December quarter. The midpoints of revenue and per-share profits were in line with consensus estimates that project growth of 17% and 21%, respectively. Wall Street expects per-share profits to rise 18% in 2011 on 7% sales growth. Scheduled to report December-quarter results on Jan. 24, Texas Instruments is a Focus List Buy and a Long-Term Buy.

MOMENTUM AND QUALITY LEADERS
All 16 of the A-rated stocks below earn scores of at least 80 in Quadrix Momentum, Quality, and Overall. Companies currently featured on our buy lists are presented in bold.
-------- 12-Month Change --------
5-Year Change
----------- (Annualized) -----------
---------- Quadrix Scores * ----------
Company (Price; Ticker)
Stock-
Market
Value
($Bil.)
Sales
(%)
Per-
Share
Profits
(%)
Oper.
Cash
Flow
(%)
Sales
(%)
Per-
Share
Profits
(%)
Oper.
Cash
Flow
(%)
Momen-
tum
Quality
Overall
Aflac ($57; AFL)
27.0
12
47
16
7
11
8
86
82
97
Agilent Technologies
($44; A)
15.6
22
302
76
1
33
(4)
98
92
96
Altera ($39; ALTR)
12.5
54
157
171
10
25
22
100
99
97
Apple ($341; AAPL)
317.9
63
74
88
36
59
62
98
99
98
Biogen Idec ($67; BIIB)
16.2
7
58
23
14
45
13
88
94
96
CSX ($69; CSX)
26.3
8
25
17
3
19
15
81
87
92
Express Scripts
($59; ESRX)
31.5
90
27
107
22
29
30
83
95
87
Google ($640; GOOG)
206.2
22
45
18
39
40
37
85
98
92
Hess ($82; HES)
26.9
18
981
90
11
17
19
98
86
99
Microsoft ($29; MSFT)
249.2
17
48
20
10
14
9
91
91
97
Newmont Mining
($57; NEM)
28.4
46
146
52
17
31
20
82
92
98
Oracle ($32; ORCL)
161.3
38
22
5
20
20
21
90
94
97
Research In Motion
($65; RIMM)
34.2
29
45
47
57
57
47
93
99
100
St. Jude Medical
($42; STJ)
13.8
9
21
30
13
15
10
80
93
91
Texas Instruments
($35; TXN)
41.7
36
151
30
2
16
(3)
86
92
98
Union Pacific ($98; UNP)
48.9
11
34
15
4
26
11
89
87
90
* Quadrix scores are percentile ranks, with 100 the best.

 


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