Seeking Top Performers


Stocks going up tend to continue going up.

Academic and industry research suggest this Wall Street maxim is true. But truth aside, the adage can also get investors into trouble. Just look back to the market meltdown of 2000. In retrospect, nobody sees buying Yahoo ($16; YHOO) at 400 times trailing earnings as a good idea. But in 1999 and 2000, thousands of people made that foolhardy purchase, buying on the basis of share-price momentum and monster growth expectations.

Moreover, since the idea of buying low and selling high is literally the bedrock of investing, many have trouble accepting that buying stocks with price momentum is a winning strategy.

Believe us, it works.

The top quintile (one-fifth) of stocks in the S&P 1500 Index as measured by Quadrix® Performance score averaged a return of 11.8% in rolling 12-month periods since October 1994, while the average stock in the index averaged a 10.4% return.

Our Performance score considers stock returns for a variety of periods up to one year. While the Performance score is an effective tool for identifying stocks that can beat the market, subscribers shouldn’t just go out and buy top Performance scorers. The chart above also shows that stocks with high Overall scores outperform top Performance scorers. Even a portfolio of the top-ranking stocks based on combined Overall and Performance scores cannot beat the Overall score on its own, though it does generate returns superior to those of the Performance score alone.

That’s the beauty of the Overall score, which considers dozens of statistics from six categories, including stock-price performance.

The Forecasts’ stock analysis starts with the Overall score, but we also know the Performance score works. So, we decided to test strategies driven by Overall score but excluding companies with low Performance scores, as well as strategies that sold stocks when they fell below a certain Performance score.

Our research shows that by purchasing top Overall scorers and selling when Performance scores fall, we could beat the average stock, but not a strategy of buying and holding top Overall scorers, as shown in the chart below. Even buying stocks based on Overall score and excluding the poorest performers doesn’t help.

So what does this mean to you? Since high Performance scores in concert with high Overall scores don’t work any better than Overall scores themselves, investors shouldn’t use them independently. Investors who prefer stocks with momentum might want to consider strong Overall scorers that also earn solid Performance scores.

Though the shares are still down from year-ago levels, Aflac ($42; AFL) has nearly tripled over the last six months. The recovery reflects an easing of fears about the insurer’s investment portfolio. Fears related to European hybrid securities peaked in January, and Aflac shares plunged on the uncertainty. Investors were concerned about the potential for bankruptcy or privatization of European banks, but concerns about such catastrophic events have waned in recent months. Aflac has a history of growing its cash flow and should have sufficient capital to absorb any losses on the hybrid securities.

Earnings-estimate momentum has also lifted the shares. Both the 2009 and 2010 per-share-profit estimates have risen at least $0.04 in the last two months, and the consensus now projects 18% growth this year and 7% next year. Despite its recent price gains, Aflac trades at just eight times estimated year-ahead earnings, 40% below the three-year average. Aflac is a Long-Term Buy.

Energen ($43; EGN) has jumped 68% over the last six months. While the shares are not particularly cheap in the wake of the run-up, Energen still trades at 11 times trailing earnings, about 13% below its three-year average P/E ratio.

In late August, natural-gas prices dipped below $3 per thousand cubic feet, to seven-year lows. The price has jumped in the last week but remains about 75% below the peak of more than $13 last summer, hurt by weak demand from homes and factories and sharply higher production in the U.S.

Natural gas is produced year-round, but demand is weak in the summer, and the natural gas is stored in underground reservoirs until needed. With stockpiles far ahead of last year’s levels, some industry watchers believe storage capacity could run out before the winter arrives. However, the low price could also prompt more utilities to start using natural gas instead of coal, boosting demand.

To protect itself against fluctuating energy prices, Energen has hedged 75% of expected natural-gas production in the second half of 2009 at an average price of $8.09 per thousand cubic feet, nearly triple current spot prices. Earning a Quadrix Overall score of 92, Energen is a Long-Term Buy.

Hospira ($42; HSP) shares have risen 75% over the past six months, lifted by consistent and strong profit growth. Not surprisingly, Quadrix Overall and Performance scores have risen in recent months.

Part of the stock’s ascent reflects health-care reform efforts. A spirited debate continues over the patent length for biotechnology drugs, with proposals ranging anywhere from five years to 14 years. Of course, the shorter the patent period, the better for companies such as Hospira, which makes biosimilars. But whatever shape reform finally takes, Hospira says it won’t hamper the current product-launch schedule and would only affect long-term pipeline decisions.

New-product growth should offset pricing pressures, and 2010 sales are expected to be up about 4%. Hospira plans to launch its second biosimilar treatment in Europe next year. The company also awaits U.S. regulatory approval to resume shipping a new generic treatment for colon cancer. Additional growth should come from Retacrit, which holds an estimated 30% share of the market for oncology and dialysis biosimilars in Europe. Hospira is a Focus List Buy and a Long-Term Buy.

Oceaneering International ($59; OII) is one of just two recommended stocks with Overall scores of at least 90 and Performance scores of at least 75. The stock jumped 5% following the release of June-quarter results, the fourth straight quarter in which shares rallied on an earnings surprise. The stock has generated an annualized total return of 27% over the past five years.

Oceaneering’s products and services support the drilling and production operations of energy companies. Its fleet of remotely operated vehicles (36% of sales and 52% of operating income for the past 6 months) can operate at depths of up to 10,000 feet.

Operating momentum has slowed in recent quarters on delays in orders for subsea umbilical tubing and a weak market for shallow-water equipment. However, Oceaneering’s strength lies in its exposure to deepwater drilling, an area of resilience during the recession. Worldwide, the number of rigs under contract has declined 12% over the past year, but utilization of deepwater rigs remains about 95%. Oceaneering is a Focus List Buy.


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