Quantitative Favorites

05/20/2005 12:00 am EST


Richard Moroney

Editor, Dow Theory Forecasts

"To screen for the best potential performing stocks, we look at 100 different variables across seven different categories" notes Richard Moroney. Here he explains his quantitative strategy and highlights some of the stocks that have earned his top rankings.

"We look at a company’s operating momentum, its recent growth in sales and earnings and cash flow and dividends. We’re looking for value relative to three and five year’s norms to see if the valuations are low or high relative to its history. We look at quality, a company’s track record, its return on assets, return on equity, return on investment. We’re looking at debt levels and interest coverage, trends for earnings estimates, and the number of up and down revisions from analysts. And we’re looking for performance, which is the stock’s return over the past 12 months, as well as volume trends. We try to find the stock that score in the top one fifth of these categories. From that point, we try to isolate the companies with the highest potential, by doing individual company analysis for Dow Theory Forecasts where we are looking for larger companies, or for Upside, where we look for smaller companies.

"We still see this as a value driven market, in terms of the quantitative factors that are working, and that’s been the case since March 2000. A few things that stand out are price to free cash flow, which has worked quite well over the last several years. Other valuations measures that have worked consistently over the last five and 20 years have been enterprise value to EBITDA, which is simply the value of the company’s debt plus equity divided by earnings before interest, taxes, and depreciation. So that puts companies on an equal footing adjusted for their debt load. And a simple price to earnings ratio seems to work pretty well. By using valuation ratios along with measures that track a company’s operating momentum or quality, you can even out those swings that value investors suffer by trying to buy high quality companies that are cheap and you can lessen the amount of volatility you will have in your portfolio versus just using a purely quantitative approach.

"Among large stocks, I think it makes sense to still have exposure to energy. I’d be buying ConocoPhillips (COP NYSE). OMI (OMM NYSE), an oil tanker company, is benefiting as China’s demand for oil goes up, the demand for transport of oil goes up. I also like Valero Energy (VLO NYSE), which is a refiner. I also like a couple of insurers, such as Allstate (ALL NYSE) and Manulife (MFC NYSE), a leading insurer in Canada. Outside of those areas, I think Nike (NKE NYSE) is attractive among consumer stocks. I think Express Scripts (ESRX NASDAQ) is attractive among health stocks.

"Among small stocks, one I like a lot is Cal-Dive (CDIS NASDAQ), which is a hybrid between a company that has production assets in natural gas and oil and is also involved in sub-sea construction and oilfield services. Another small stock I like quite a bit is Asta Funding (ASFI NASDAQ), a very small company with a $300 million market cap. Their purpose is buying up distressed consumer debt for pennies on the dollar and trying to collect on that debt. It’s an interesting business model with some risk. The stock is quite cheap, and it’s put up some interesting numbers."

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