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Searching Out the Optimal Portfolio of “Revelation” Stocks

Inside the Numbers - Why We Haven’t Bottomed Yet

Posted on | October 23, 2008 Time: 11:16 pm |

Warning - Ground May No Longer Be Under You...

Warning - Ground May No Longer Be Under You...

This is a market that rips away at conventional thinking, even the thinking that was “conventional” just a few weeks ago. When the credit crisis first got the national attention that comes with large-scale bankruptcies and market declines, there was a broad consensus that investors should seek out companies with the least amount of earnings risk and the safest balance sheets.

So what has happened to investors that followed a path towards safer equities? Turns out they’ve underperformed the market…consider these telling results from a screen I ran using the Finviz software:

The Baseline Figure: S&P 500 performance, 1 Month:  -23.6%

Breaking down the numbers further, 220 of the S&P 500 member stocks (44%) are down in excess of 30%
in the past month.

72%, or 364 of these 500 stocks are down at least 20% in the same period.

Now let’s overlay my screen, which filters for one measure of earnings stability, one measure of cash flow, and two measure of balance sheet strength:

Earnings Stability - Forward P/E under 10
Cash Flow - Under 20x Free Cash Flow
Balance Sheet  - Debt/Equity under .5
Balance Sheet - Current Ratio above 1.0

Running this screen on the S&P 500, only 66 stocks fit the criteria. These are all under-leveraged companies with ample cash flow to meet current obligations, and trading for less than a market earnings multiple. And in aggregate, they have underperformed the market in the past month:

86.4% (57/66) are down over 20% in the past month, 14 percentage points higher than the ratio for unfiltered stocks;

59% (39/66) are down over 30% in the past month, 15 percentage points higher than for unfiltered stocks.

The list of 66 is actually well-diversified amongst sectors, with every sector represented by at least 3 companies in the filtered list.

What We Need to Bottom

Until the market shows evidence of investors going long by bottom-fishing for earnings and balance sheet stability, I don’t see the broad indexes making a bottom. As impossible as it is to believe, we’re still seeing above-average performance in stocks with growth profiles over value profiles. Most of the sideline cash, the smart money that has not been participating for several months, should be looking for value over growth when they re-enter the equities markets. To date, this flow of capital has unfortunately not been occurring.

Ryan Barnes

More on this topic (What's this?)
FABER: S&P COULD DECLINE 20% FROM HERE (THE PRAGMATIC CAPITALIST, 1/27/10)
Glenn Neely: Multi-month decline (All Allan, 1/22/10)
Emini S&P: Another Setup For A Rebound (Short-Term Trading, 1/30/10)
Read more on S&P 500 (SPX), 2008 Financial Crisis at Wikinvest
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Category: Broad Markets, Fundamental Analysis, Investing Philosophy
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