Even On Autopilot, Quadrix Works
8/25/2014
Just set it and forget it. Whether roasting a chicken in those rotisserie ovens advertised on infomercials or enrolling in automatic payroll deductions for a 401(k), the ease promised by that tagline is highly alluring. No need for constant monitoring, no need for occasional tweaks.
While we do not suggest readers ignore our weekly advice, there is some evidence that putting a Quadrixbased stock portfolio on cruise control can be an effective strategy.
Most of our research involves using 12month holding periods. This time we wanted to see how an investor would fare buying the top onefifth of stocks in the S&P 1500 by Overall score and holding that portfolio for up to five years. Such analysis represents more than just curiosity — our LongTerm Buy List contains stocks we believe offer superior totalreturn potential over the next 24 to 48 months.
On an absolute basis, the oneyear holding period delivered the highest average, median and geometric mean returns since 1994, as shown below. The geometric mean calculates a compound growth rate, helping to neutralize the variability of individual observations.
OVERALL SCORE EFFECTIVE OVER TIME


The effectiveness of the Quadrix Overall score stands the test of time. The top onefifth of S&P 1500 stocks outperformed the average stock by an average of 2.3% in the 224 rolling 12month periods since 1994. Over twoyear holding periods, the top onefifth of stocks outperformed by an annualized 2.2%, with that figure dipping to 1.3% for a fiveyear investment horizon.


 Top OneFifth Of S&P 1500 Stocks Versus Average Stock 


1 Year 
2 Years 
3 Years 
4 Years 
5 Years 

Annualized average return (%) 
2.3 
2.2 
1.9 
1.8 
1.3 
Annual. standard deviation (%) 
5.1 
2.9 
2.6 
2.9 
2.6 
Return/risk ratio 
0.46 
0.74 
0.76 
0.63 
0.50 
Annualized median return (%) 
2.1 
1.9 
1.1 
1.4 
1.3 
Geometric mean return (%) 
2.2 
2.1 
1.9 
1.8 
1.2 
Number of rolling periods 
224 
212 
199 
188 
175 
Winning percentage (%) 
67 
75 
73 
69 
61 
While the annualized outperformance of top scorers for two and threeyear periods lagged the average for oneyear periods, returns looked more attractive relative to the volatility of that outperformance. We calculate a return/risk ratio by dividing average outperformance by standard deviation, a measure of how tightly relative returns are dispersed around the average. Top Overall scorers generated return/risk ratios of at least 0.74 for two and threeyear periods, versus 0.46 for oneyear periods. Four and fiveyear holding periods averaged lower annualized returns than shorter periods but still managed better return/risk ratios than oneyear periods.
QUADRIX CATEGORY SCORES


Among S&P 1500 stocks since 1994, the Quadrix Overall score and Value score have shown solid predictive power over various holding periods up to five years. In contrast, Momentum, Quality, and Earnings Estimates scores have been a mixed bag, while Financial Strength and Performance scores have been ineffective.


 Top OneFifth Of S&P 1500 Stocks Versus Average Stock 


1 Year (%) 
2 Years (%) 
3 Years (%) 
4 Years (%) 
5 Years (%) 

Quadrix Overall score


Average annual. outperformance 
2.3 
2.2 
1.9 
1.8 
1.3 
Annualized standard deviation 
5.1 
2.9 
2.6 
2.9 
2.6 
Winning percentage 
67.0 
75.0 
73.0 
69.0 
61.0 
Quadrix Momentum score


Average annual. outperformance 
0.4 
(0.1) 
0.0 
0.2 
0.2 
Annualized standard deviation 
6.4 
4.0 
3.1 
2.9 
2.4 
Winning percentage 
56.0 
51.0 
49.0 
52.0 
53.0 
Quadrix Value score


Average annual. outperformance 
2.9 
1.9 
1.3 
1.3 
1.1 
Annualized standard deviation 
10.4 
5.7 
4.1 
3.8 
3.5 
Winning percentage 
59.0 
58.0 
54.0 
63.0 
63.0 
Quadrix Quality score


Average annual. outperformance 
0.3 
0.0 
0.2 
0.0 
(0.6) 
Annualized standard deviation 
6.5 
4.6 
3.5 
3.5 
2.9 
Winning percentage 
50.0 
49.0 
56.0 
55.0 
39.0 
Quadrix Financial Strength score


Average annual. outperformance 
(0.8) 
(0.4) 
(0.2) 
(0.2) 
(0.3) 
Annualized standard deviation 
6.8 
4.4 
3.2 
3.0 
2.6 
Winning percentage 
40.0 
39.0 
43.0 
54.0 
53.0 
Quadrix Earnings Estimates score *


Average annual. outperformance 
0.0 
0.0 
0.3 
0.1 
(0.1) 
Annualized standard deviation 
7.0 
3.7 
2.5 
2.0 
1.9 
Winning percentage 
60.0 
59.0 
57.0 
56.0 
61.0 
Quadrix Performance score


Average annual. outperformance 
(0.2) 
(1.0) 
(0.9) 
(0.9) 
(1.1) 
Annualized standard deviation 
11.4 
6.2 
4.7 
3.9 
3.8 
Winning percentage 
54.0 
54.0 
48.0 
52.0 
49.0 
* We have data for the Earnings Estimates score back to 2004; all the rest go back to 1994. 
Not only did top scorers provide better riskadjusted outperformance over long holding periods, they were also more likely to outperform. Holding periods from two to four years boasted higher winning percentages than oneyear periods, meaning top scorers topped the return of the average stock more often.

In the table below we present 15 stocks that score above 75 for Value, above 85 for Overall, and also score well for some of the most effective individual Quadrix factors. Three intriguing options are discussed below.
Aetna ($78; AET) consistently scores well in Quadrix, its Overall rank topping 80 in 21 of the past 24 months. It has earned a Value score of 80 or higher in 11 consecutive months and scores in the top half of our research universe for the five Quadrix factors that have proved highly effective across multiple time horizons, shown in the table below. The stock also looks cheap based on its P/E ratio of 12, which earns a factor rank of 84 and is 24% below the median for S&P 1500 managedcare stocks.
Aetna's stock has rallied 25% in the past year, ahead of the 22% average for its peer group and the S&P 1500's 20% gain. But in recent weeks, renewed fears of rising utilization trends have pressured the shares. Medical costs are finally beginning to creep higher, as they eventually do during expansionary periods. However, the uptick could prove more gradual than in prior periods, considering higher deductibles and new efforts to constrain costs as the government takes a greater interest in the industry. Aetna, already a LongTerm Buy, is being added to the Buy List.
Southwest Airlines ($31; LUV) earns the maximum Overall score of 100, bolstered by all six category scores ranking in the top 30% of our research universe. Both sectorspecific scores are 99. The airline enjoys steadily improving returns on assets, equity, and investment. Free cash flow jumped 63% to $1.42 billion in the 12 months ended June. Sales have risen in 17 of the past 18 quarters, including 8% growth in the June quarter.
Southwest jumped off to a strong start in the current quarter, with traffic up 6.6% in July. Rising analyst estimates anticipate 36% higher pershare profits in the second half of the year, compared to average estimated growth of 23% for S&P 1500 airline stocks
The shares have held up well in the past month, producing an 11% total return while Southwest's peers averaged 3%. As the largest domestic carrier, Southwest enjoys strong U.S. demand trends, while avoiding the increased competition on transatlantic flights. In July, Southwest said it plans to resume a "measured" expansion strategy that calls for seatcapacity growth of 2% to 3% next year. Southwest Airlines is rated A (above average).
UGI's ($51; UGI) Value score of 78 reflects aboveaverage ranks for 58% of factors within the category. The stock's price/sales, price/cash flow, and enterprise (enterprise value/earnings before interest, taxes, depreciation, and amortization) ratios score above 80 in Quadrix. UGI also trades at least 19% below the median for S&P 1500 naturalgas utilities for all three of these ratios. The stock's trailing P/E of 17 is 9% below its peergroup median.
Do not dismiss UGI as solely a value play. It also earns outstanding scores for Momentum (90) and Earnings Estimates (86). This combination is in short supply — fewer than 50 S&P 1500 stocks score above 75 for Value, Momentum, and Earnings Estimates. Pershare profits grew more than 25% in the first two quarters of 2014, building on 36% growth in 2013. Sales have risen at least 5% in 10 straight quarters, a trend analysts expect to continue in the seasonally light September quarter.
UGI is more than a gas utility. It generates most of its revenue from distributing propane, both in the U.S. and overseas. Last month, the company announced a threefortwo stock split and raised its dividend 10%. UGI, yielding 2.5%, is a Buy and a LongTerm Buy.
