The Best Of Value And Growth

8/15/2011


Large-company value stocks delivered annualized returns of 11.1% from 1928 to 2010, versus 8.8% for large growth stocks. But in 12 of the past 30 years, growth has outperformed value. Given the inconsistent performance from one year to the next, investors should consider filling their portfolio with both types of stocks.

Our Focus List highlights our very best investment selections and draws from both camps. We actually prefer stocks with both growth and value characteristics. Our strategy has been successful, as the Focus List has outgained the S&P 500 Index in five of the last seven years. Since 2003, the Focus List has gained 64.4% on a fully invested basis excluding dividends and transaction costs, versus 33.2% for the S&P 500 Index.

FOCUS LIST RETURNS
Year
Focus List
Price Chg.
(%)
S&P 500
Index
Price Chg.
(%)
1994 †
0.7
(0.1)
1995
30.4
34.1
1996
23.9
20.3
1997
26.6
31.0
1998
23.3
26.7
1999
22.9
19.5
2000
14.0
(10.1)
2001
(16.0)
(13.0)
2002
(28.9)
(23.4)
2003
20.2
26.4
2004
17.5
9.0
2005
8.1
3.0
2006
12.9
13.6
2007
22.8
3.5
2008
(48.8)
(38.5)
2009
40.0
23.5
2010
19.5
12.8
2011 *
(9.4)
(6.8)
1994-Present *
249.1
155.0
Annualized *
7.8
6.0
2003-Present *
64.4
33.3
Annualized *
5.9
3.7
* Through Aug. 9.    † Starting Dec. 23.
Note: Returns assume fully invested portfolios and exclude dividends and transaction costs.

A high price/book ratio often means investors see stronger growth opportunities for a particular stock relative to a peer with a low price/book ratio. However, plenty of stocks with low price/book ratios deliver excellent profit growth.

Any system classifying value versus growth has limitations, especially one based on a single ratio. In fact, the best stocks tend to exhibit both value and growth characteristics.

In th table below, we provide several valuation ratios for the stocks in our Focus List, illustrating that they can look cheap by some metrics but pricey by others. All of the stocks on that list seem capable of solid profit growth and superior capital gains. Below we review four Focus List stocks, two distinguished by their attractive values, and two that stand out more because of their growth characteristics.

Value selections

Alliance Data Systems ($85; ADS) provides direct-marketing services, customer-loyalty programs, and private-label credit cards to help businesses reach audiences fracturing into smaller groups. The shares have jumped 20% this year yet still look attractively valued. At less than six times trailing cash provided by operations, the stock trades 47% below its five-year average and 31% below its peer group. Versus five-year averages, the shares also trade at discounts of 24% on sales and 43% on earnings.

Alliance has delivered six straight quarters of double-digit sales growth. With all three business units poised for more growth, management in July raised its full-year profit guidance. Alliance is a Focus List Buy.


Some of Dover's ($54; DOV) peers have issued cautious commentary about the second half of 2011. But Dover's management remained bullish in its July 22 earnings release, raising the company's 2011 outlook. Dover operates more than 40 different businesses ranging from refrigeration systems to smartphone microphones, a diversified approach that helps steady the company against cyclical volatility. About 46% of 2010 revenue came from overseas as Dover continues to push into emerging markets, particularly China, Malaysia, India, Mexico, Brazil, and Eastern Europe.

Dover has raised its dividend in 56 consecutive years, including a 15% hike in early August. Management expects free cash flow to equal at least 10% of revenue this year, up from 8% over the last three years. Dover's 2011 revenue target implies free cash flow will jump at least 49%, the strongest growth in eight years. Dover, which raised its quarterly dividend 15% earlier this month and now yields 2.3%, is a Focus List Buy and a Long-Term Buy.

Growth selections

Apple's ($374; AAPL) growth is stunning. Cash provided by operations has risen at least 46% in each of the last seven quarters. June-quarter sales leapt 82%, missing by less than one percentage point a sixth consecutive quarter of accelerating growth.

Apple's iPad, expected to be revamped in time for Christmas, could account for more than 60% of global tablet-computer shipments this year. The iPhone is also poised to grab more share, with the world's largest wireless carrier, China Mobile ($46; CHL), reportedly agreeing to start selling the iPhone 4 to its 611 million subscribers at the end of October.

Quadrix® also singles out Apple, the only stock in our research universe of roughly 4,500 companies that earns maximum ranks of 100 for the Overall score and both of our sector-specific scores. Apple is one of just 10 stocks with scores above 70 in all six Quadrix categories. Within that select group, only Apple scores 95 or higher in at least four categories. Apple is a Focus List Buy and a Long-Term Buy.


MasterCard's ($323; MA) plastic profits have delivered golden returns for shareholders. The stock has soared 28% since we first recommended it in April, including a 13% bump on the day it posted June-quarter results. Free cash flow more than doubled to $2.0 billion in the 12 months ended June. Revenue has risen in nine consecutive quarters, with growth accelerating in the last three.

MasterCard's results are irrevocably linked to swings in consumer spending. But the company is also positioned to profit from the long-term shift away from cash. Also, MasterCard's rapidly expanding international business drove June-quarter growth and could help offset the effects of a sluggish U.S. economy. About 53% of total purchase transactions and 60% of revenue came from overseas during the latest quarter.

Rising analyst estimates see MasterCard growing per-share profits 25% this year on 18% higher revenue, which would exceed the company's three-year annualized growth rate for both measures. MasterCard is a Focus List Buy and a Long-Term Buy.

FOCUS LIST
The Focus List illustrates the complexities of trying to classify stocks as purely value or growth. Some attractively valued stocks like Exxon Mobil ($72; XOM) and Dover ($54; DOV) have solid growth histories and excellent potential. On the other hand, even some high-growth stocks that don't look particularly cheap based on traditional valuation ratios — such as Apple ($374; AAPL) and DirecTV ($43; DTV) — earn fairly high Quadrix Value scores, in part because they look cheap relative to their own historical norms.
Sales Growth
EPS Growth
Est. EPS Growth
Price/Earnings
Ratio
Price/Sales
Ratio
Price/Cash
Flow Ratio
Company (Price; Ticker)
Last 12
Months
(%)
Quadrix
Rank
Last 12
Months
(%)
Quadrix
Rank
Next 12
Months
(%)
Quadrix
Rank
Trailing
Quadrix
Rank
Trailing
Quadrix
Rank
Trailing
Quadrix
Rank
Agilent Technologies
($34; A)
30
85
132
86
22
57
15
58
2.2
35
11.9
42
Alliance Data Sys.
($85; ADS)
24
80
39
62
10
36
21
34
1.7
45
12.2
41
Altera ($36; ALTR)
33
87
68
73
(4)
17
14
61
5.9
11
14.0
32
Apple
($374; AAPL)
73
96
91
79
22
57
16
55
3.6
20
14.4
30
Bed Bath  & Beyond
($53; BBBY)
14
63
32
57
16
46
17
49
1.5
48
13.3
35
CSX ($22; CSX)
22
77
41
63
23
58
15
57
2.3
33
9.5
58
DirecTV ($43; DTV)
27
82
51
66
24
60
18
43
1.6
47
8.0
68
Dover ($54; DOV)
22
77
51
66
19
52
14
62
1.4
51
9.7
56
Exxon Mobil
($72; XOM)
22
77
46
64
15
46
10
81
0.9
66
7.1
75
IBM ($171; IBM)
14
63
20
48
12
39
14
62
2.0
38
10.5
51
MasterCard
($323; MA)
13
62
28
54
20
54
21
34
7.1
9
18.9
19
Oracle
($28; ORCL)
31
85
33
57
9
34
17
46
4.3
17
13.5
34
Walter Energy
($76; WLT)
70
96
309
94
120
89
14
66
3.5
21
11.0
48
Average
S&P 500 stock
11
53
18
49
16
44
18
53
1.7
49
11.3
51
Average
S&P 1500 stock
11
52
3
50
18
47
19
48
1.6
52
12.2
46
Notes: Quadrix scores are percentile ranks, with 100 the best. Averages exclude growth rates above 200%, P/E ratios below 0 or above 75, P/S ratios above 5, and P/CF ratios below 0 or above 50.     

 


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