Quality Stocks Are Still on Sale
Investors have suffered through 14 bear market plunges in the post-WWII era. Fortunately, those declines have been followed by 14 bull markets.
The bounce-backs are typically far more powerful, but predicting the inflection points with accuracy can be difficult. From a historical standpoint, stocks have delivered an average return of +22% in the four months before the economy shows signs of recovery. So waiting around for too many “green shoots” can be costly.
Of course, we all know the current story: a broad recovery has lifted pretty much everything higher. It has been a great ride, to be sure. But these massive rallies have led to some second-guessing.
Fortunately, while it might seem that virtually every ticker symbol from here to China has shot skyward and is now out of reach, there are many stocks that called in sick during the 2009 rally.
#-ad_banner-#Believe it or not, there were more than 507 U.S. traded stocks that could only manage single-digit returns last year, and 2,296 actually lost ground. That means a large swathe of the market was either late to last year’s party, or missed out altogether.
When the market zoomed last year, investors began flocking to the most volatile stocks available. And why not? They stand the most to gain when traders are in a buying mood.
Billions of dollars in assets flowed into lower-quality stocks (i.e. companies with weaker competitive positions, more debt, etc.). The companies with the most question marks were severely oversold in the downturn — and thus bounced the furthest once it was clear that the sky wasn’t falling.
While the “junk rally” raged, investors almost forgot about sturdy blue-chippers like IBM (NYSE: IBM) and Procter & Gamble (NYSE: PG), which drifted only modestly higher. I’ve seen a number of different studies on the phenomenon. While the criteria might change, they all tell the same story…
- Last August, Morningstar reported that rock-solid companies with wide moats climbed just +4.8% from their lows, versus +16.6% for those with narrow moats and +26.1% for firms with no moats. In other words, the fewer competitive advantages and barriers to entry for a company, the sharper the bounce in stock price.
- In 2009, reliable dividend-paying members of the S&P 500 posted an average gain of +26.2%, while non-payers rung up much stronger returns of +65.3%.
- Last October, using measures like return on equity, Citigroup found that companies ranked ‘C’ and ‘D’ (the lowest two categories) outperformed the highest-ranked stocks by a of +55% to +11%.
- Ford Equity Research recently determined that stocks representing the highest quintile in terms of earnings quality have bounced an average of +66% from their lows, less than half the +152% surge in stocks belonging to the lowest quintile.
I’ve seen other studies based on factors like dividend yield, debt-to-equity ratio and earnings revisions. They all point to the same trend: the stronger the company, the more investors have ignored it.
All of this has turned the usual investment paradigm upside down. Imagine walking into the supermarket and seeing ground chuck priced at $5 a pound, right next to filet mignon for $4 a pound. That’s pretty much what the market offers us today.
The last time we witnessed a junk rally this pronounced was in the early 1970s.
Now is the time to overweight your portfolio with high-quality stocks. I’d start shopping in the Dow Jones aisle (this could be a great time for the “Dogs of the Dow“) and work outward from there.