Archive for the ‘High Quality Stocks’ Category

Dividend Growth Stocks for a Low Price Return Stock Market

Friday, December 18th, 2015
  • ACE, ADP, Microsoft and Raytheon look to us to be attractive long-term dividend growth investments; and they have been so in the long-term and short-term past
  • High quality, low leverage stocks with long histories of persistent dividend payment and growth are important in the low forward price return US stock market expected for the next few years
  • Free cash flow is to be prized in stock selection when thinking about weathering storms
  • Stocks that have paid and increased dividends though multiple recessions could help investors sleep on those investments

Most analysts agree that total return for US stocks over the next few years will be modest.  When expected price returns are high, dividend yield takes a back seat for many investors (not necessarily conservative or retired investors), because of their low contribution to total return.  When expected price returns are modest or low (as they are now), dividends get up in the front seat, and maybe even the driver’s seat.

It seems to us that at least for a good part of a portfolio for retirees and near-term pre-retirees, dividends should be in the front seat.  That is not necessarily something for younger investors with at least, say, 10 years before retirement; and who are still in the earning and asset accumulation stage of their financial lives.

So this investment note is probably more suitable for the retiree or near-term retiree crowd (or any other investor who for whatever reason is attracted to dividend stocks).  And this note is not about reaching for yield.  It is about finding high quality, steady dividend growth companies, that have weathered the test of time; and up and down markets.

We always begin our search for opportunity with a quantitative filter.  We think you really have to do that, unless you rely in tips on TV, radio or investment media — something that will not expose you to the full range of possibly good ideas. And, more importantly, such tips will seldom give you much depth — but you can research them to see if they work for you if that is your cup of tea.

I suppose you could say this article also a tip, but we think its different.  It is different, in great part, because we take you through the steps of how we got to our conclusion, so you have the basis to make your own evaluation, and to determine what additional research you need to do for your self if any of the ideas here seem potentially attractive.

There are thousands of ways to set up a filter with different criteria categories and different parameters within the categories; and we use several different filters to generate ideas.  This is just one filter, not the only filter than makes sense to us.

There are over 8,000 listed securities on the NYSE, NASDAQ and AMEX.  Nobody can review them all, so a filter reduces the size of the universe to examine.  Our preliminary quantitative filter yesterday reduced 8,000+ securities to a list of 15.   Here is how we go those 15.


  • Dividend Growth Consistency: Paid and increased dividends for at least 8 years (through 2008-2009 market crash)
  • Dividend Growth Rate: minimum 3% annualized over 1, 3, and 5 years
  • Current Yield: >= 2%
  • Trailing Payout Ratio:  less than 100% (except for REITs or MLPs)
  • Debt-to-Equity: maximum 2
  • PEG Ratio: > 0 and < 3
  • 8-Year Price Change: better than zero (traverses last recession)
  • 1-Year Price Change:  better than negative 5%
  • Liquidity: 3-month average per minute trading volume is at least $10,000
  • Quality Rating: by at least one of Value Line, Standard & Poor’s, MSCI or Wright Investors’ Services
  • Consensus 12-mo Target Price/Market Price: >=1


This table lists the 15 filter survivors, along with their sector and industry.

(click image to enlarge)


We are concerned these days about free cash flow, that could be helpful if there is margin compression due to a sales slump, increased interest costs, or some other adverse development.  Because of that concern, we visually examined free cash flow charts for the 15 filter survivors and found 6 stocks with a nice enough year-by-year pattern and enough total free cash flow to give us some comfort.  Their charts are shown below, also presenting their price, their revenue and their dividend.


Of the 15 filter survivors, 6 look best after reviewing charts of free cash flow.

Declining revenue at LEG is unattractive.  Declining revenue at RTN is much less concerning, because it was based on defense sequester, which will end; and most importantly RTN’s critical role in weapons systems for the war with ISIS.

2015-12-17_ ACE 2015-12-17_ ADP 2015-12-17_ LEG 2015-12-17_ MSFT 2015-12-17_ RTN 2015-12-17_ SJM

Also because of concerns about a tepid global economy, we would currently favor quality stocks more than usual as an extra level of comfort in the event that things go poorly in the markets.  This table shows the quality ratings for the 6 stocks remaining in our filter.



A synopsis of how the firms describe their rating goes like this:

  • S&P Capital IQ Earnings & Dividend Rank: Growth and stability of earnings and dividends
  • Value Line Financial Strength Rating: balance sheet leverage, business risk, the level and direction of profits, cash flow, earned returns, cash, corporate size, stock price, cash on hand, and net of debt
  • MSCI Quality Index: Durable business models with sustainable competitive advantage; high ROE, stable earnings with low business cycle correlation, and  strong balance sheets with low leverage.
  • Wright Investors’ Service Quality Rating: (1) Liquidity, (2) Financial Strength, (3) Profitability & Stability, and (4) Growth. The ratings are based on 32 factors (8 for each of the four rating elements) using 5-6 years of corporate records and other investment data. The highest possible score is AAA20.  The lowest possible score excluding certain designations for insufficient information or time frame, is CCC0.  They consider the minimum rating for “quality” to be BBB4.

By these ratings, MSFT is clearly best and SJM is probably worst.

The Street (mostly Sell-Side firms) publish their 1-year forward price targets.  The graphics that follow present the composite Street view of each of the 6 stocks.


Looking at the analyst estimates, LEG looks least attractive.  ADP looks most attractive to the Street consensus

2015-12-17_Consensus_ACE 2015-12-17_Consensus_ADP 2015-12-17_Consensus_LEG 2015-12-17_Consensus_MSFT 2015-12-17_Consensus_RTN 2015-12-17_Consensus_SJM



Two leading independent analytics services are Standard and Poor’s Capital IQ and Value Line.  They approach the matter of rating differently.  S&P is more qualitative and Value Line is more quantitative.  They sometimes agree and often do not.  An example here is on ADP where they are as far apart as they can possibly be, with S&P saying stay away and Value Line saying jump on board.

Fidelity publishes the view of a variety of mostly independent analysts, and then Reuters uses a proprietary weighting system to come up with a single score from 0-10 called StarMine.  They weight the analyst opinions based on the historical accuracy of each analyst firm for the sector in which the stock they are rating belongs.

S&P Capital IQ uses a 1-5 rating system, where 5 is best and 1 is worst (Stars are for year ahead return, and Fair Value is market price versus the S&P view of fair value).  Value line uses a rating system from 1-5, where 1 is best and 5 is worst (their Earnings Predictability is a relative measure of the reliability of earnings forecasts).

Here is how each service rated each of our 6 selections.

By these three services, LEG looks better than in the Street consensus and ADP looks worst, based on S&P giving ADP an outright Sell  and a most overvalued price versus Fair Value.  ACE is clearly on top according to these sources.




Nothing beats reading the full SEC filings, and studying the full set of financial statements and footnotes.  That said a summary look at selected financial data can focus attention on a stock or divert attention elsewhere.

The first table presents absolute Dollar amounts (in $millions) for selected financial data.  The second table presents the same data on a common size basis (each data point expressed as a percentage of sales).



MSFT has the best EBITDA margin, but apparently pays more tax, because it has the same net income ratio as ACE and ADP which have lower EBITDA margins.  The all have good Current Ratios (MSFT the best).  SJM has a negative tangible equity, because its intangibles exceed its book equity.


LEG is the weakest in overall growth rates.

ACE seems to be the most consistent average to above average performer, and may benefit most by rising interest rates.

MSFT has been weak on EPS growth, but strong on sales and dividend growth.  They have the resources to keep the dividends coming, and their negative EPS has been significantly impacted by write-downs of discontinued businesses, which may not be as problematic going forward.

RTN has poor historical revenue growth, but restocking and development of the US high-tech weaponry arsenal is likely, and they would be a direct beneficiary.

SJM has had earnings growth problems (as has LEG), but has kept dividends growing nicely, and they have some product lines with strong brand equity that should carry them forward (e.g. Smuckers jellies and jams, Jiff peanut butter, Pillsbury, Folgers coffee, Kibbles n’Bits and 9Lives cat food)


A really important point for us at this juncture in this time of expected low price returns and high importance of dividend return (and for the needs or our mostly near retirement and retired clients), is the persistence and growth of dividends through difficult times.

Each stock in this list of 6 has paid and increased dividends for at least 11 years (RTN) and as long as 44 years (LEG).  To put those long periods into more functional perspective, we looked up all of the recessions in the last 44 years and counted how many recessions each stock lived through while paying and increasing their dividend.

The more recessions they weathered, the more likely they are, we think, to weather the next one.  If a retiree can count on the dividend, even if the stock price is gyrating (particularly if the retiree can live on the income from the portfolio alone), the more the retiree can sleep at night, and be less concerned about the price of the stock in short periods of a year or two.

LEG persisted with dividend growth through 7 recessions — pretty impressive.  ADP persisted through 6 recessions — also pretty impressive.

Just because a stock persisted through fewer recessions is not necessarily a ding on performance, because they may not have existed at all of those times.  MSFT is an example of that.

Lastly for growth, we engaged in an entirely hypothetical calculation just to possibly provide some scope of future dividend payback of the original purchase price.  These calculations should not be relied upon, just reflected upon.

We projected the 7 years historical dividend growth rate forward 7 years; then the 5-year history out 5 years; then the 3-year history out 3 years to see how much of the purchase price might be recovered before a possible sale of the stock at the end of those periods.

Then we projected out 5 years again using the average of the 7, 5 and 3 year dividend growth rates; and once more using only the minimum growth rate among the 7, 5 and 3 years rates.

By those calculations MSFT looks best and SJM works, and none are bad.


Most of you probably have a reasonable idea what most of the 6 stock do, but here are business descriptions to paint a possibly fuller picture of each company’s business.

ACE: ACE Limited is a holding company. The Company is a global insurance and reinsurance company. The Company offers commercial insurance products and service offerings, such as risk management programs, loss control and engineering and complex claims management. It provides specialized insurance products to niche areas, such as aviation and energy. It also offers personal lines insurance coverage, including homeowners, automobile, valuables, umbrella liability and recreational marine products. In addition, it supplies personal accident, supplemental health and life insurance to individuals in select countries. The Company’s segments include Insurance – North American P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance and Life.

ADP: Automatic Data Processing, Inc. (ADP) is a provider of human capital management (HCM) solutions and business process outsourcing. The Company operates through two segments: Employer Services and Professional Employer Organization (PEO) Services. The Employer Services segment offers a range of business outsourcing and technology-enabled HCM solutions. These offerings include payroll services, benefits administration, recruiting and talent management, human resources management, insurance services, retirement services and payment and compliance solutions. The Company’s PEO business, ADP TotalSource, offers small and mid-sized businesses human resources (HR) outsourcing solution through a co-employment model. ADP TotalSource includes HR management and employee benefits functions, including HR administration, employee benefits and employer liability management, into a single-source solution, including HR administration, employee benefits and employer liability management.

LEG: Leggett & Platt, Incorporated is a manufacturer that conceives, designs and produces a range of engineered components and products found in homes, offices, automobiles and commercial aircraft. The Company operates in four segments: Residential Furnishings segment, which manufactures steel coiled bedsprings; Commercial Fixturing & Components segment, which include work furniture group that designs, manufactures, and distributes a range of engineered components and products primarily for the office seating market; Industrial Materials segment consists of wire group, which operates a steel rod mill and tubing group, which supplies welded steel tubing and Specialized Products segment designs, manufactures and sells products, including automotive seating components, specialized machinery and equipment, and service van interiors. Its brands include Semi-Flex, ComfortCore, Mira-Coil, Lura-Flex, Superlastic, Super Sagless, Tack & Jump, Schukra, Gribetz, Masterack and Hanes, among others.

MSFT: Microsoft Corporation is engaged in developing, licensing and supporting a range of software products and services. The Company also designs and sells hardware, and delivers online advertising to the customers. The Company operates in five segments: Devices and Consumer (D&C) Licensing, D&C Hardware, D&C Other, Commercial Licensing, and Commercial Other. The Company’s products include operating systems for computing devices, servers, phones, and other intelligent devices; server applications for distributed computing environments; productivity applications; business solution applications; desktop and server management tools; software development tools; video games; and online advertising. It also offers cloud-based solutions that provide customers with software, services and content over the Internet by way of shared computing resources located in centralized data centers. It provides consulting and product and solution support services.

RTN: Raytheon Company, together with its subsidiaries, is a technology Company that specializes in defense and other Government markets. The Company develops products, services and solutions in markets: sensing; effects; command, control, communications and intelligence (C3I); and mission support, as well as cyber and information security. The Company operates in four segments: Integrated Defense Systems (IDS); Intelligence, Information and Services; Missile Systems, and Space and Airborne Systems. The Company serves both domestic and international customers, as both a prime contractor and subcontractor on a portfolio of defense and related programs primarily for Government customers. The Company’s products include Global Integrated Sensors, Integrated Air & Missile Defense, Cybersecurity and Special Missions, Global Training Solutions, Land Warfare Systems, Advanced Missile Systems, Tactical Airborne Systems, Advanced Missile Systems and Electronic Warfare Systems.

SJM: The J. M. Smucker Company is a manufacturer and marketer of consumer food and beverage products and pet food and pet snacks in North America. The Company has four segments: U.S. Retail Coffee, U.S. Retail Consumer Foods, U.S. Retail Pet Foods, and International, Foodservice and Natural Foods. The Company’s U.S. retail market segments consist of the sale of branded food products to consumers through retail outlets in North America. The Company’s International, Foodservice and Natural Foods segment represents sales outside of the U.S. retail market segments. The Company’s principal consumer food and beverage products are coffee, peanut butter, fruit spreads, shortening and oils, baking mixes and ready-to-spread frostings, canned milk, flour and baking ingredients, juices and beverages, frozen sandwiches, toppings, syrups, pickles, condiments, grain products and nut mix products. The Company’s pet products consist of dry and wet dog food, dry and wet cat food, dog snacks and cat snacks.


We own ACE, ADP and RTN; are thinking about MSFT, which we have owned in the past.

  • ACE as an insurance company will probably benefit by interest rates as they rise
  • ADP will benefit by an improving jobs picture, and ever more complex benefits and HR issues
  • RTN will benefit by the increasing reliance of high-tech warfare, and the current war with ISIS
  • MSFT is coming back with its Windows 10 system, its own computer brand, and cloud platform (and a new and better CEO)

This note was written on Wednesday December 16, 2015.  The following charts were generated at end-of-day Friday December 18, 2015.


These chars plot the dividend adjusted percentage performance of each of the 6 stocks versus an S&P 500 ETF (in black).

10 Years Monthly



3 Years Weekly




3 Months Daily



5-Yr Projection of Mean Reversion for S&P 500 Price, GAAP Earnings and Dividends

Monday, July 28th, 2014

One approach to seeking fair value, or simply what is most likely, over the intermediate-term to long-term is the assumption of mean reversion.  That approach basically assumes that long-term means act a bit like gravity or a magnetic attraction that pulls on prices, earnings or dividends to return to the mean growth level.

It may take a lot of patience for that approach, and if there is a permanent structural change in markets, the former mean may not continue to serve as gravitational or magnetic attraction.   On the other hand structural changes are few and far between, making mean reversion a pretty good bet more often that not.

So, lets discover the long-term means for S&P 500 prices, GAAP earnings and dividends; and then apply those means to make reasonable 5-year projections of those dimensions into the future.

Let’s use the S&P monthly data available from Professor Shiller at Yale (you can download the data for yourself to do various studies on your own).  That data begins in the 1800’s using precursors to the S&P 500, such as the Dow Industrials and other data, but we will confine our study to actual S&P 500 data from its inception in 1957 (more than 57 years of data).


The long-term compound growth rate of the price of the S&P 500 is 6.88%.  Continuing that growth curve out 5 years comes up with a future  price projection in the vicinity of 2700.  That is around 36% to 37% above the current level.



The long-term compound growth rate of the GAAP earnings for the S&P 500 is 5.90%.  Continuing that growth out 5 years comes up with a future earnings level projection in the vicinity of $115 per index share. That is around 14% above the most recent 2-month trailing earnings levels.



The long-term compound growth rate of dividends for the S&P 500 is 5.37%.  Continuing that growth out 5 years comes up with a future earnings level projection in the vicinity of $45 per index share.  That is around 20% above the most recent 12-month  trailing dividend level.



Now let’s look at the growth trends since the effective beginning of the internet era in 1995, and also use the long-term growth factors from that beginning to see where that ends up.

In 1995, HTML had been around for a few years, and eventually it included ways to add images, not just text. That image capability was added and expanded to browser capability when Mark Andreesen released the Netscape browser in November 1994.  The internet rapidly transformed from a Geeky academic and military technology, to a personal and commercial technology.  It has been disruptive and transformative in business and for stocks ever since.

Keep in mind that if January of 1995 was particularly high or low relative to fair value, the projection would be comparably high or low.  For reference and to make your own judgment about that, here are the multiples at as of December 30, 1994:

  • GAAP earnings yield 5.95% (P/E ratio 18.81)
  • Dividend yield 2.90%
  • Moody’s long-term Baa corporate bonds 9.1%
  • 30-yr Treasuries 7.89%
  • 10-yr Treasuries 7.81%
  • 5-year Treasuries 7.81%
  • 2-yr Treasures 7.69%
  • 3-mo Treasuries 5.6%

The yield curve was essentially flat, while today it is steep. and the Fed was not such an intrusive player.


These charts have two 5-year projections.  The black dotted plot is a simple exponential trendline on the data from the beginning of 1995 projected out 5 years.  The red solid line is a projection from the beginning of 1995 at the long-term growth rate of the price of the S&P 500.

The exponential trend line is heavily influenced by the extremes of the dot-com bubble, while the long-term growth rate projection is impacted by the degree of “normalcy” of the starting point multiple.

The exponential projection suggests there is little if any price growth in the 5-year future of the S&P 500.  The long-term growth rate applied to the internet era suggests a price level 5 years out in the vicinity of 2900, or about 31% to 32% cumulative price change over the next 5 years.

At a minimum, the explosive growth of the past few years driven by both earnings recovery from the deep 2008 crisis, and by P/E multiple expansion.  Those forces are behind us, not in front of us.


There are many optimists among the analyst community, and there are long-term optimists who expect a correction, but there is a much more limited number of outright long-term pessimists.

Two prominent pessimists are Bill Gross of PIMCO and Jeremy Grantham of GMO.

  • PIMCO, as you may know, is predicting stock price appreciation in the 3% to 5% range over the next several years.
  • GMO is another important voice expressing concerns. Their quarterly asset class 7-year forecast is for negative 1.7% rate of return for US large-cap stocks (essentially the S&P 500), negative 5.2% return for small-cap stocks (essentially the Russell 2000), and positive 2.8% for high quality stocks. They see positive 3.6% returns for emerging market stocks,

As to High Quality Stocks, we suspect for the most part GMO was thinking about large-cap stocks that have not participated fully in this momentum market, and which are particularly strong otherwise – such as with consistent but modest revenue and dividend growth, low leverage and strong Balance Sheets, and wide business moats.  See our post of high quality stocks.)


The exponential trendline from the beginning of 1995 suggests earnings are already too high by about $10 per index share ($100 versus a 5-year projection of about $90).  Let’s hope that is not a good forecast, because the absolute level of earning and the associated negative growth rate would probably crush the stock market.

We do have historically high profit margins, historically low corporate borrowing costs, stagnant wages, above historical earnings growth rates, above average P/E multiples, and stock market capitalization that is at an historically high ratio to US GDP.  Those are key fundamental risk factors that should be evaluated.

The long-tern earnings growth rate applied to the earnings at the beginning of 1995 projected out 5 years, suggests earnings of about $122 per index share, or about 21% above current levels.

Standard & Poor‘s forecasts 2014 GAAP earnings of $119.87 (basically the 5-yr projection level at the long-term growth rate); and $136.39 for 2015.  The 3-year period leading up to the end of 2015 would have a compound earnings growth rate of 16.39% (about 2.5 times the long-term earnings growth rate).  They may be right, but if they are way wrong, there will be major market problems.



The exponential 5-year projection for S&P 500 dividends goes to about $40 per index share (about a cumulative 7% growth).  The long-term dividend growth rate applied from the beginning of 1995 suggests a 5-year projected cumulative growth of about 22% to about $46 per index share.


On balance, we have a greater faith in the growth of dividends than in the growth of either earnings or index price.  We also share GMO’s prediction that high quality stocks will do better over the next few years than large-caps in general.  Additionally, our client basis is at or near the end of the accumulation stage of their financial lives, where assets cannot be replaced easily or at all from new wages or business profits.  That means asset preservation is key, further pushing us in the direction of dividend and high quality bias within the stocks allocation, along with some amount of allocation to partially market neutral assets, such as long/short funds or positions.


Move Toward High Quality Stocks For Late Stage Bull Market (27 stock selections)

Tuesday, July 15th, 2014

A basic investment concept is to that high quality stocks fare better in down markets than low quality stocks, and therefore in late stages of a Bull market with generally fully valued stocks, tilting equity allocations toward high quality is prudent.

Accordingly, we set out to identify high quality stocks.  We know that sources such as S&P and ValueLine render quality ratings, but they are each a “black box” to a great extent, and we wanted to test quality using some other criteria as well.

We made the assumption that high quality could be identified by:

  • trading liquidity
  • strong balance sheets
  • revenue growth
  • long unbroken strings of dividend payment and increase
  • wide moats against competition.

With those conceptual criteria in mind, we applied these specific filter criteria to all stocks traded in the United States:

  • Wright’s investment grade rating minimum “BBB4” (see ratings description) for liquidity, financial strength, profitability and growth, based on 32 factors (577 passed filter)
  • Member David Fish’s Dividend Champions, Challenger or Contenders (“CCC”) – stocks that paid and increased dividends each year for at least 5 years; some did for decades (543 passed filter)
  • Morningstar “Wide Moat” designation (258 passed filter)
  • Revenue growth over each of 5, 3 and 1 years at least 3% (1796 passed filter)
  • Dividend growth over each of 5, 3, and 1 years at least 3% (657 passed filter)
  • Four part Balance Sheet  filter (1454 passed filter)

Four part Balance Sheet filter:

  • Tangible equity increased at minimum 3% annualized rate from 5th prior fiscal year to most recent completed fiscal year
  • Total Liabilities/Tangible Assets not more than that ratio 5  fiscal years ago
  • Current Ratio >= 0.9
  • Quick Ratio >=0.7

To understand the size of the universe we filtered, consider these sources with more than a combined 8,500 stocks:

  • NYSE has 4,668 listings (almost entirely stocks)
  • NASDAQ has 2,735 stocks
  • NYSE/AMEX has 425 listings
  • OTC BB has 836 stocks

From that universe, when we applied all of the criteria simultaneously, only 9 stocks passed, which we called our highest quality scenario.

We cross-referenced our list with quality ratings from S&P and from ValueLine, and found agreement.  The difference is that our list is much shorter than their lists.  Our criteria are more restrictive than those for S&P and ValueLine, resulting in the limited number of selections.

Highest Quality Scenario (9 stocks):

Pass All Filter Criteria

GGG Graco Inc. Capital Goods
GWW W.W. Grainger, Inc. Consumer Cyclical
MMM 3M Co Capital Goods
MON Monsanto Company Basic Materials
MSFT Microsoft Corporation Technology
QCOM QUALCOMM, Inc. Technology
SXL Sunoco Logistics Partners L.P. Energy
TIF Tiffany & Co. Services
UNP Union Pacific Corporation Transportation

If we did not apply the Balance Sheet criteria, but applied all of the others, 18 stocks  in addition to the highest quality 9 passed the filter.  These 18 stocks also substantially agree with quality ratings from S&P and ValueLine.

Best Performing Scenario (18 stocks):

Pass all criteria except Balance Sheet

ABC AmerisourceBergen Corp. Health Care
ADP Automatic Data Processing Services
BAX Baxter International Inc. Health Care
BEN Franklin Resources, Inc. Financial
BF-B Brown-Forman Corporation Consumer Non-Cyclical
CHRW C.H. Robinson Worldwide, Inc. Transportation
CLB Core Laboratories N.V. Energy
COST Costco Wholesale Corporation Services
EFX Equifax Inc. Services
EV Eaton Vance Corp Financial
FAST Fastenal Company Capital Goods
FDS FactSet Research Systems Inc. Technology
JKHY Jack Henry & Associates, Inc. Technology
MCK McKesson Corporation Health Care
NKE Nike Inc Consumer Cyclical
OKS Oneok Partners LP Utilities
SYK Stryker Corporation Health Care
TROW T. Rowe Price Group Inc Financial

If we required only the Wright’s investment grade rating, the Dividend CCC membership, and the Morningstar Wide Moat, there were an additional 38 stocks, for a total of 65 out of over 8,500 that passed some level of our high quality screen. A few of the stocks in this last group had only average quality ratings from either S&P or ValueLine, but most were high quality by those two independent sources as well.

Of those last 38, there were 17 that passed 1 or more of the additional criteria; and 21 that passed only the three minimum criteria — however, those 3 minimum criteria are quite important and powerful as they reduced over 8,500 stocks to merely 65.

Let’s look into the 27 stocks in the top group of 9 and second group of 18 high quality stocks.

If the 27 stocks were purchased in equal weights 10 years ago (as of June 30, 2014) and then rebalanced monthly — as might be done in a tax exempt or tax deferred account, but probably not in a taxable account — this chart compares the level of value accumulation of the S&P 500 versus the value accumulation by the 27 high quality stocks.


Basically, the blew the doors off of the S&P 500.  A criticism of this backtest is the benefit of hindsight.  Stocks that have only paid and increased dividends for 5 to 9 years as of today, would not have been selected 10 years ago based on the filter criteria, and their revenue and growth over the past 5, 3 and 1 years may not resemble those stats 10 years ago.

Let’s look at that in a more granular way to see recent periods where the filter is more likely to have selected these stocks.

This histogram shows how a monthly rebalanced, equal weight portfolio would have done versus the S&P 500 on a quarter-by-quarter basis.


Over the past 3, 2 and 1 years, the 27 stocks would have outperformed, but during this recent melt-up they generated less alpha than in prior periods.  Our hypothesis is that in a correction or worse, they would be better relative performers.

Let’s look now at their risk adjusted returns through the lens of Sharpe Ratios.


They have higher volatility than the S&P 500 as an equal weighted group, but superior risk adjusted returns.  The higher volatility, which is not major in significance, may be the result of a less diversified portfolio than the S&P 500.

Before, we move on to a look at the performance of the different subgroups of the 65 filter survivors, here is a high level view of the 27 by market-cap, style, and economic sensitivity.


They are large-cap and mid-cap, growth or value/growth blend by style; with a balance of cyclical, defensive and moderately economically sensitive stocks.  The standout data point is that small-caps didn’t produce any survivors.

Now let’s look at different filter survivor sub-groups.

Referring to the selection process as scenarios, we have identified 5 slices of the survivors:

  • Scenario I: Dividend CCC, Wright investment grade and Morningstar Wide Moat only (23 stocks)
  • Scenario II:  Scenario I criteria plus Balance Sheet criteria (15 stocks)
  • Scenario III: Scenario I criteria plus revenue and dividend growth criteria (18 stocks)
  • Scenario IV: Scenario I plus revenue and dividend growth and Balance Sheet criteria (9 stocks)
  • Scenario V: All stocks in Scenarios I-IV (65 stocks)

This first table calculates the “price only” IRR of each scenario of equal weighted stocks in  “buy and hold” portfolios (no rebalancing this time).

Scenario IV (all criteria met) is the superior price performer in all periods including 10, 7, 5, 3, 1 years and 6 months year-to-date 2014.

Scenario III (revenue and growth requirement, but not Balance Sheet) came in second and  outperformed the S&P 500  for 10, 7, 5 and 3 years; but fell behind the S&P 500 over that 1-year and 6-month periods.  In that 1-year and 6-month periods, Scenario II (Balance Sheet requirement, but not revenue or dividend growth) pulled into second place, beating the S&P 500.

Is the slight rotation from growth focus to Balance Sheet focus related to a concern about the impact of expected interest rate rises?


As an alternative way to examine the same price-only IRR data, this table presents the return spread between the Scenarios and the S&P 500.


Here is a table of 7-year and 5-year annualized growth of sales, reported earnings per share and dividends.

In this case, Scenario III (the revenue and dividend growth factors) understandably have somewhat stronger growth characteristics.  There has been a huge earnings recovery in the S&P 500, but that includes the effect of coming out of a large earnings hole.  The high quality stocks have lower 5-year earnings growth, because they did not have the earnings hole experienced by the S&P 500 in its entirety.


Looking at valuation (as of June 30, 2014), the high quality stocks have higher valuation multiples, but when we get to the PEG ratio (forward P/E divided by estimated 5-year forward earnings growth rate), the valuations for Scenarios II, III and IV are  in the reasonable range (basically 1x to 2x).

Scenario I (Dividend CCC, Wright’s investment grade, and Morningstar Wide Moat alone, is expensive  with a PEG of 3.63x (lacks sufficient growth).


These two tables present valuation data for the 9 and 18 stocks discussed above.




If you are interested in the current technical condition, potentially for deciding when to enter one or more of the stocks, you might want to be aware of opinions such as those from BarChart or

Not all of these are in good technical shape, but from a fundamental perspective most of these are probably a pretty good go-to list for high quality.

Here are links to each with technical ratings (change the symbol on the linked pages for the security you want to see):


Disclosure:  We own 13 of the 27 stocks in this blog post and may buy more.