Going Beyond Quadrix

5/2/2011


Sometimes readers ask us why we recommend ABC Co., with a Quadrix Overall score of 92, over XYZ Co., with a Quadrix Overall score of 97.

It's a fair question, because we frequently discuss the effectiveness of our Quadrix system for identifying stocks that outperform. But while it is true that stocks scoring in the high 90s tend to outperform those scoring in the low 90s, the relationship is not perfect. Some stocks that score 97 will underperform stocks that score 92, or even 82.

Despite Quadrix's power, we never make buy or sell decisions based solely on Quadrix scores, for at least three reasons:

• Quadrix relies mostly on historical statistics to compute its percentile ranks and cannot take into account nonstatistical factors that may affect a certain company or industry. For that reason, individual company analysis is key to our stock-selection strategy. Given a choice between a company that scores 95 Overall but faces increasing competition and one scoring 85 that boasts a rich pipeline of new products, the lower scorer may prove a better investment.

• Quadrix works much better within some sectors than others, as shown in the table below. In a back-test of 12-month returns for stocks in our Quadrix research universe since the end of 1994, the top one-fifth of each sector as measured by Overall score outperformed the average stock in the sector. However, the top scorers delivered outperformance of more than 2% in six sectors and less than 1% in the other four. To augment our stock-selection power, we developed sector-specific scores to use in concert with traditional Quadrix scores.

• Quadrix rewards growth, and many companies amass gaudy growth numbers without laying a foundation for success going forward. Quadrix scores may overstate the appeal of companies that make a lot of acquisitions, borrow heavily to fund expansion, or ride a cyclical wave that lifts even the leakiest boats in their industries.

In our stock-selection process, we consider a variety of factors other than today's Overall scores. We like stocks that earn consistently high Overall scores over a period of time, and we also favor stocks that do not rank extremely low in any of the individual Quadrix category scores, particularly Value.

As the table below illustrates, the Value score has displayed excellent predictive power in all 10 market sectors. While Value-driven portfolios should perform well over the long haul, their returns can be quite volatile. Also, we don't expect the Value score to dominate the other category scores like it did in 2008 and 2009.

WHAT WORKS BEST BY SECTOR
In the 184 rolling 12-month periods since the end of 1994, the top one-fifth of consumer-discretionary stocks in the Quadrix universe as measured by Overall score outperformed the average stock in the sector by an average of 3.2%. Quadrix scores particularly effective within a given sector are presented in bold.
-------- Average Outperformance Of Top One-Fifth By Quadrix Score --------
Sector
Momen-
tum
(%)
Value
(%)
Quality
(%)
Fin'l
Str.
(%)
Earns.
Ests.
(%)
Perfor-
mance
(%)
Overall
(%)
Cons. Discret.
3.0
5.5
(0.2)
(1.6)
1.0
1.6
3.2
Consumer Staples
5.0
5.0
(2.7)
(3.2)
0.1
0.8
2.5
Energy
(0.8)
5.6
1.2
0.2
1.0
(0.1)
0.9
Financials
2.9
4.9
2.5
0.0
1.4
0.1
3.9
Health Care
1.8
5.6
(0.3)
0.7
3.4
(1.5)
0.8
Industrials
0.7
6.1
(2.8)
(2.2)
(1.9)
0.3
0.9
Materials
2.3
5.9
0.7
1.6
4.7
0.8
2.1
Technology
1.9
4.8
0.9
(0.3)
(0.7)
1.8
3.4
Telecom
6.5
11.3
(3.0)
(5.5)
4.7
(0.1)
2.4
Utilities
0.7
1.9
0.1
0.0
0.7
0.3
0.8
Quadrix Universe
2.7
5.5
(1.6)
(1.1)
1.5
1.1
2.7

The table below presents 26 quality stocks (all rated A, or above average) in seven sectors. All 26 stocks, including the three reviewed below, earn high Overall ranks and also look good as measured by our sector-specific scores and the Quadrix category scores most effective in their sector.

Apple ($350; AAPL) has earned an Overall score above 80 for more than 24 consecutive months. Five of Apple's six category scores are above 65, including its Value score of 74.

The consistency in Quadrix reflects Apple's tremendous operating momentum. The company has reeled off 31 consecutive quarters of double-digit sales growth. Revenue, up 83% in the March quarter, has accelerated for five consecutive quarters. Free cash flow surged 172% to $5.60 billion, boosting net cash assets to $29.23 billion, or about 9% of Apple's stock price. Shares jumped 2% on the results, which eased fears that the Japan disasters had crimped the company's supply chain.

On the heels of its earnings report, Apple filed a lawsuit accusing Samsung Electronics, both a rival and a supplier, of copying the design, packaging, and user interface of its iPhone and iPad. Days later Samsung responded with its own lawsuit describing similar violations. Apple is no stranger to litigation. It seeks the dismissal of an antitrust lawsuit alleging that iTunes is a monopoly. In December, Nokia ($9; NOK) filed a lawsuit in Germany and the Netherlands claiming that Apple's iPhone and iPad violate 13 of its patents. Nokia has also sued Apple in the U.S. and Britain. Finally, at least two consumers sued for privacy invasion because the iPhone and iPad regularly transmit their locations back to Apple. Apple is a Focus List Buy and a Long-Term Buy.


For the March quarter, BlackRock ($199; BLK) earned $2.96 per share excluding special items, up 23% and $0.21 above the consensus. Revenue grew 14% to $2.28 billion, marking the sixth straight quarter of double-digit growth. Assets under management rose 8% to $3.65 trillion, reflecting new business and investment gains. The company also said it plans to increase stock repurchases during the year.

BlackRock says its clients have shown a greater tolerance for risk in 2011. Equity investments tend to carry a more favorable fee structure than fixed assets, so BlackRock stands to gain from renewed interest in stocks and other higher-risk investments. The world's biggest asset manager, BlackRock is also riding the wave of popularity in exchange-traded funds, a market that has averaged 30% growth over the past decade.

BlackRock's Overall score, currently 97, has exceeded 90 in each of the past seven months. Four of the six Quadrix category scores are above 85. The stock rallied on the March-quarter results but seems reasonably valued at 18 times trailing earnings, 36% below their three-year average. BlackRock, yielding 2.8%, is a Buy and a Long-Term Buy.


Exxon Mobil ($87; XOM) scores among the top 30% of stocks in our research universe for all six Quadrix categories. That broad strength supports the stock's Overall score of 97, which has risen steadily in the past six months. Strong operating momentum and surging oil prices have helped push shares 40% higher since September. Even among peers, Exxon stands out, earning sector-specific scores of 94 for Reranked Overall and 94 for 12-Factor Sector. Exxon's shares, at 14 times trailing earnings, trade at a 39% discount to the average energy stock.

With the $25 billion XTO Energy acquisition, Exxon's proved reserves for oil and natural gas rose last year by the largest margin since 1999. Natural gas reserves jumped 16%, but prices remain depressed. Production projects tend to take years of planning, and Exxon, as it showed during the recession, doesn't appear much concerned by short-term volatility in energy prices. Oil production should get a boost now that Exxon has been cleared to resume drilling in the Gulf of Mexico.

Exxon is scheduled to post March-quarter results on April 28, after our publishing deadline. Rising Wall Street estimates call for per-share profits of $2.06, up 55%. Exxon is expected to report 27% higher revenue, which would mark the fifth straight quarter of double-digit growth. Exxon Mobil, yielding 2.0%, is a Focus List Buy and a Long-Term Buy.

26 STOCKS WITH SECTOR APPEAL
All of the 26 stocks below earn an A (above-average) rating on our Monitored List, as well as high Overall scores and ranks above 60 in our sector-specific scores and the Quadrix category scores that work best in their sector. The 12-Factor Sector score considers 12 factors that work particularly well within a given sector, while the Reranked Overall score reweights the six category scores used to derive the traditional Overall score, favoring the most effective scores for the sector. Stocks currently recommended for purchase are presented in bold.
--------------------------------- Quadrix Scores * ---------------------------------
Sector-Specific
------- Scores -------
Company (Price; Ticker)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
12-
Factor
Sector
Reranked
Overall
Sector
Advance Auto Parts
($66; AAP)
62
74
86
76
42
55
87
68
66
Cons.
Discretionary
Aflac ($54; AFL)
85
98
84
71
11
16
93
88
95
Financials
American Express
($47; AXP)
81
76
67
47
91
56
91
73
92
Financials
Ameriprise Financial
($61; AMP)
86
86
63
38
92
61
94
88
97
Financials
Apache ($126; APA)
84
66
72
92
95
55
93
86
85
Energy
Apple ($350; AAPL)
97
74
100
95
67
44
98
100
91
Technology
Applied Materials
($16; AMAT)
98
86
83
87
71
55
99
99
94
Technology
BlackRock ($199; BLK)
95
72
87
86
94
38
97
98
94
Financials
Capital One Financial
($55; COF)
96
91
60
42
94
67
97
93
98
Financials
Chevron ($109; CVX)
85
79
73
80
98
82
98
98
98
Energy
ConocoPhillips
($81; COP)
90
75
52
39
99
85
92
70
81
Energy
Corning ($21; GLW)
81
88
94
89
17
38
95
81
89
Technology
CSX ($77; CSX)
83
63
91
61
95
67
95
93
99
Industrials
Dell ($16; DELL)
93
96
61
41
24
39
90
99
78
Technology
DirecTV ($47; DTV)
82
79
99
56
28
58
94
66
80
Cons.
Discretionary
Exxon Mobil
($87; XOM)
91
78
72
71
99
76
97
94
97
Energy
Hess ($81; HES)
82
87
72
44
96
59
96
91
99
Energy
Intel ($22; INTC)
55
96
88
95
8
34
91
83
82
Technology
J.P. Morgan Chase
($45; JPM)
75
94
50
79
95
41
93
82
97
Financials
Lam Research
($49; LRCX)
97
94
95
91
36
59
100
92
99
Technology
Microsoft ($26; MSFT)
67
92
91
92
21
17
92
70
72
Technology
NASDAQ OMX Group
($27; NDAQ)
86
92
78
45
89
76
99
88
100
Financials
Research in Motion
($55; RIMM)
53
98
100
95
42
16
95
96
75
Technology
Union Pacific
($100; UNP)
82
66
89
65
77
45
92
74
95
Industrials
UnitedHealth Group
($47; UNH)
65
86
86
49
74
76
96
98
97
Health Care
Walter Energy
($134; WLT)
96
69
99
96
95
75
100
97
100
Materials
* Quadrix scores are percentile ranks, with 100 the best.

 


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