Top Scores In Top Stats

7/4/2011


Not all valuation ratios are created equal.

Many can identify stocks poised to outperform, but some work better than others. Our Quadrix® Value score harnesses the power of a variety of valuation ratios, helping the Forecasts determine which companies represent genuine values.

Higher Value scores generally equate to higher returns. We divided stocks in the Dow Jones U.S. Index into 33 equal-numbered groups based on Value score. In rolling 12-month periods since the start of 1992, the top-scoring basket averaged a return of 20.3%, and stocks in the top three baskets averaged returns of 18.4%. The five highest-scoring baskets delivered the five highest returns, and the five lowest-scoring baskets delivered the lowest returns. In the middle — equating roughly to scores between 40 and 70 — the return differential is not large.

We frequently see similar trends — high returns at the highest scores and a muddle in the middle — in 33-basket studies. In fact, several individual valuation ratios provide higher returns at the top than the Value score. Listed in the table below are six such metrics — enterprise ratio (enterprise value divided by earnings before interest, taxes, depreciation, and amortization), price/sales, price/free cash flow,
price/book, price/earnings, and price/cash flow.

VALUE METRICS THAT WORK
We divided the Dow Jones U.S. Index into 33 equal-numbered baskets based on several valuation statistics. The top-scoring basket as measured by Quadrix Value score averaged a return of 20.3% in rolling 12-month periods since 1992, while the top three baskets returned 18.4% and the top six baskets returned 17.1%. All six of the valuation ratios listed below delivered higher returns than the Value score based on the same back-test.
Basket
Quadrix
Value
Score
(%)
Enterprise
Ratio
(%)
Price/
Sales
(%)
Price/Free
Cash Flow
(%)
Price/
Book
(%)
Price/
Earnings
(%)
Price/
Cash
Flow
(%)
Top-Scoring
20.3
22.6
24.7
22.3
22.9
22.7
21.6
Top 3
18.4
20.4
19.6
19.8
19.7
19.1
18.9
Top 6
17.1
18.5
17.8
18.5
17.5
17.6
17.5
Bottom 3
8.5
11.0
9.8
15.2
10.9
11.6
10.1
Bottom 6
8.5
10.7
9.8
15.1
10.2
11.4
10.2

Check out the chart above, and you'll see that while the relationship is far from perfect, returns trend generally higher as the Value scores increase. With many individual valuation ratios, we see a larger expanse of bars with no discernable trend in the middle, such that only the highest and lowest scores distinguish themselves from the average. In some cases, the very lowest scorers manage returns superior to those of all but the highest scorers. The use of multiple statistics to derive the Value score helps smooth out these disparities.

All of the stocks in the table below earn a Value score of 90 or higher, which would normally qualify them for one of the top three baskets based on that rank. All 14 companies also earn scores above 80 in at least one of the six particularly effective individual valuation ratios discussed above. In the following paragraphs, we review four of those companies.

Aflac ($45; AFL) looks cheap even relative to its peers in the much-maligned financial sector. At less than eight times trailing earnings, the stock trades 51% below its sector average and 12% below the average life and health insurer in the S&P 1500 Index. Versus its own five-year history, the stock trades at discounts of 47% on earnings, 28% on sales, and 33% on book value.

Shares have been choppy this year, as concerns about Aflac's exposure to European debt and the Japanese economy worried investors. The company sold some of its troubled debt in the March quarter and will book $610 million in pretax losses in the June quarter, primarily from unloading investments in Portuguese banks. Aflac's abundant cash flow and sturdy balance sheet will help it absorb the hit. Net of debt, Aflac holds $1.74 billion, or $3.68 per share, in cash.

The stock's yield of 2.7% is high by historical standards, as the yield has averaged 1.5% over the last 10 years. In April, management expressed confidence that later in 2011 it would raise the dividend for a 29th consecutive year. Aflac is a Buy and a Long-Term Buy.


Intel ($21; INTC) has proved it can adapt to softening demand for personal computers. In June, Intel reiterated its 2011 guidance, calling for revenue growth in excess of 20%. That confidence reflects Intel's exposure to emerging markets, where PC demand has been more resilient, and its ability to place its semiconductors in a broad range of consumer products. Most recently, Comcast ($25; CMCSa) said Intel processors would power its new set-top boxes.

In a year when the S&P 500 Technology Sector Index has slipped 1%, Intel shares have squeezed out a 2% gain. The stock is 11% below its 52-week high set in May, providing investors with an attractive entry point.

At 10 times trailing earnings, the stock's P/E languishes near its lowest level in more than a decade. Yet analyst estimates are drifting higher, with the consensus calling for Intel to earn $2.29 per share this year, implying 12% growth. The shares trade at less than 10 times the 2011 estimate, 36% below the average semiconductor stock in the S&P 1500 Index. Intel is a Buy and a Long-Term Buy.


Any trepidation harbored by investors toward Microsoft ($26; MSFT) is understandable. Demand for personal computers remains weak, and Microsoft has failed to recreate the success of its once-ubiquitous Windows operating system in the mobile market. Over the last eight years, the share price has risen just 1%, despite the company shaving nearly 22% off its share count during that period through a series of aggressive buyback programs.

In June, Microsoft introduced Office 365, an online version of its popular software suite. With the move, Microsoft takes aim at Google ($494; GOOG), which has siphoned off corporate customers with its own Web-only applications. Monthly charges for Office 365 will range from $2 to $27, versus a flat annual fee of $50 for Google Apps. The market for such cloud-computing services is projected to grow more than 27% a year to reach $73 billion by 2015.

Shares look cheap from every angle. At less than 11 times trailing earnings, the stock trades 34% below its five-year average and 44% below systems-software peers in the S&P 1500 Index. Excluding net cash of $4.49 per share, Microsoft's trailing P/E is less than nine. Shares also trade at discounts to historic averages based on trailing sales, operating cash flow, and book value. Microsoft, yielding 2.5%, is a Long-Term Buy.


NASDAQ OMX Group ($24; NDAQ), since losing out on its bid to purchase NYSE Euronext ($33; NYX), has considered other acquisitions in an industry where economies of scale can provide a huge advantage. NASDAQ didn't wait long to make an offer for LCH.Clearnet, Europe's largest clearinghouse. LCH.Clearnet is reportedly weighing multiple offers. NASDAQ could also consider a merger with the London Stock Exchange. But the stock's near-term outlook and cheap valuation make it a compelling pick even if it fails to land either deal.

Wall Street sees NASDAQ earning $2.44 per share in 2011, implying 22% growth, on 9% higher revenue. Shares trade at 10 times the 2011 profit estimate, a 35% discount to its peer group. The stock's trailing price/earnings ratio of 11 seems unlikely to return to the five-year average of 20 any time soon. But if the P/E merely holds at 11 and NASDAQ meets the 2011 consensus, shares stand to gain 12% by early next year. An expansion to the three-year average P/E of 13 would drive a 32% gain. NASDAQ's Value score has consistently exceeded 80 for the past year, and the company currently earns a 95. The stock is a Buy and a Long-Term Buy.

GENUINE VALUES
All 14 of the A-rated stocks in the table earn Quadrix Value scores of at least 90 and also score above 80 in at least one of the six particularly effective valuation ratios presented below. For example, Aflac ($45; AFL) earns a rating of 97 for price/free cash flow, which means the company is cheaper than roughly 97% of U.S.-traded stocks on this ratio. Stocks recommended for purchase are listed in bold.
Quadrix Scores
Company (Price; Ticker)
Div.
Yield
(%)
Market
Value
($Bil.)
Value

Enterprise
Ratio

Price/
Sales
Price/
Free
Cash
Flow
Price/
Book
Price/
Earnings
Price/
Cash
Flow
Overall
Industry
Aflac ($45; AFL)
2.7
21.3
98
NA
64
97
46
83
NA
85
Life & Health
Insurance
Ameriprise Fin'l
($56; AMP)
1.6
14.5
91
NA
56
81
65
79
NA
82
Asset
Management
Applied Materials
($13; AMAT)
2.5
16.9
94
84
50
73
44
83
64
89
Semiconductor
Equip.
Capital One Fin'l
($51; COF)
0.4
23.7
92
NA
58
97
87
93
NA
94
Consumer
Finance
Corning
($18; GLW)
1.1
27.9
91
42
19
68
64
89
82
87
Electronic
Components
Dell ($16; DELL)
0.0
30.8
94
88
85
83
20
86
75
99
Computer
Hardware
Freeport-McMoRan
($50; FCX)
2.0
48.2
90
91
35
74
23
86
73
93
Metals &
Mining
Hess ($71; HES)
0.6
24.2
91
88
76
0
65
89
91
85
Integrated
Oil & Gas
Hewlett-Packard
($35; HPQ)
1.4
76.6
98
87
81
80
49
91
88
79
Computer
Hardware
Intel ($21; INTC)
3.4
120.5
93
85
32
49
35
85
80
99
Semiconductors
J.P. Morgan Chase
($40; JPM)
2.5
158.7
95
54
52
NA
82
87
80
82
Diversified
Fin'l Svcs.
Microsoft
($26; MSFT)
2.5
219.6
92
80
26
75
19
84
67
95
Systems
Software
NASDAQ OMX
($24; NDAQ)
0.0
4.3
95
69
56
85
86
81
72
90
Specialized
Finance
Valero Energy
($25; VLO)
0.8
14.1
94
86
98
89
82
71
86
88
Oil/Gas Refining
& Mktg.
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not Available.

 


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