Tag Archives: growth

Follow Free Cash Flow Not EPS

Summary Momentum in earnings is a simple and effective investment idea. A company’s profitability can be described by EPS and FCFPS. Momentum in FCFPS lets investors select stocks with higher potential return than momentum in EPS. Momentum in earnings is a fairly popular criterion for selecting companies that could potentially be a good investment. The idea behind this is very simple, but also quite sound. Steadily increasing profits over a long period of time indicate that this trend is likely to continue in the future. Moreover, if profits grow at a consistent pace, it is also safe to also assume that the company will be doing well in the future. When investors talk about momentum in earnings, they are usually referring to EPS momentum – that is, companies that have a steadily increasing EPS over a long period of time. But another indicator that investors should pay attention to is Free Cash Flow per Share (FCFPS). The thing is that Free Cash Flow is seen by many investors as a metric that reflects real company profits more accurately than Net Income. This, first and foremost, is due to the difference in the way CAPEX is factored into these two indicators. We will try to figure out which momentum in which factor EPS or FCFPS lets investors select companies with the highest potential return. In order to do this, we are going to look at two portfolios. One will be based on EPS and the other on FCFPS. We are going to look at 1,500 largest US companies traded on the US stock exchange from 01/01/2008 until the present. We are going to look at EPS and FCFPS growth over the past twenty quarters (five years). The indicators are TTM. This way, we are going to get YoY EPS and FCFPS growth for every quarter. For the first portfolio, we want to select companies with stable EPS growth. Thus, we are going to select companies that post EPS growth at least 17 times over the past 20 quarters. We will accept that a company can post EPS losses no more than three times, since profit is an indicator that can be affected by temporary negative factors, which will not necessarily be reflected in future earnings growth dynamics. For the second portfolio, we are interested in companies with stable FCFPS growth. We are going to select companies that have posted FCFPS growth for at least 14 out of the past 20 quarters. The reasoning behind this is similar to the EPS-based portfolios, but the requirements are less strict because Free Cash Flow is by nature a lot more volatile than Net Income – it is directly affected by CAPEX and Working Capital changes, which are smoothed in Net Income. We are not interested in companies that posted drops in EPS and FCFPS over the given time period. In spite of the strict criteria outlined above, this is still possible if a company’s EPS and FCFPS decreased so much during a particular quarter that it was unable to recover afterward. Moreover, in order to make sure that the growth trend is not over, one of our criteria is going to be that the current EPS and FCFPS values are the highest for the given period. A lot of companies will match the criteria we have outlined. We need to focus on those who have posted the most stable EPS and FCFPS growth. In order to measure stability, we can use the EPS Growth Sharpe Ratio and FCFPS Growth Sharpe Ratio – the higher these values are, the more stable growth in EPS and FCFPS is for a given company. EPS Growth Sharpe Ratio is calculated as the ratio of average EPS growth for a given period (20 quarters) and the standard deviation of this growth. The Sharpe Ratio for FCFPS is calculated in the same way. In order to make sure that our portfolio contains securities that are posting consistent growth, we are going to select the top 40 securities by EPS Growth Sharpe Ratio and FCFPS Growth Sharpe Ratio that have made it through the previous filters. The market usually recognizes and values companies that post stable EPS or FCFPS growth over a long period of time. This is why these companies can rarely be purchased at an attractive price in terms of Valuation. Since our goal entails not only selecting stocks according to EPS or FCFPS momentum, but also evaluating which indicator can bring in more profits, we need to select securities that are moderately priced relative to EPS and FCFPS respectively. In the first portfolio, we will leave only securities with a maximum P/E ratio value of 25. In the second portfolio, we will leave securities with a maximum P/FCFPS ratio value of 25. Thus, we are getting rid of securities that are obviously overvalued. We are looking at quarterly data, so it would make sense for us to rebalance our portfolios every quarter in order to have the most relevant selection of securities. The graph below shows the comparison between the two portfolios we have described. (click to enlarge) FCFPS Portfolio performs way better than EPS Portfolio. Only in 2011 EPS Portfolio had higher return than FCFPS Portfolio. This result confirms that momentum in FCFPS is more prominent driver of stock returns than momentum in EPS. We already mentioned the possible explanation to such a result. Free Cash Flow reflects cash that was generated by the company in the recent period, whereas Net Income doesn’t include present investments but include past investments as Depreciation and Amortization. Current list of stocks in FCFPS Portfolio is the following. Apple Inc. (NASDAQ: AAPL ), AutoZone (NYSE: AZO ), CB Richard Ellis Group (NYSE: CBG ), Deluxe Corporation (NYSE: DLX ), F5 Networks (NASDAQ: FFIV ), Jazz Pharmaceuticals (NASDAQ: JAZZ ), Jack Henry & Associates (NASDAQ: JKHY ), Kennametal Inc. (NYSE: KMT ), Mednax (NYSE: MD ), The Middley Corporation (NASDAQ: MIDD ), Mettler Toledo International Inc. (NYSE: MTD ), NeuStar (NYSE: NSR ), Priceline Group Inc. (NASDAQ: PCLN ), Red Hat Inc. (NYSE: RHT ), Roper Technologies (NYSE: ROP ), Sirius XM Holdings Inc. (NASDAQ: SIRI ), Scripps Networks Interactive (NYSE: SNI ), SolarWinds (NYSE: SWI ), Universal Health Services Inc. (NYSE: UHS ), USANA Health Sciences Inc. (NYSE: USNA ), United Therapeutics Corporation (NASDAQ: UTHR ). Current list of stocks in EPS Portfolio is the following. Ametek Inc. (NYSE: AME ), AutoNation Inc. (NYSE: AN ), AutoZone , Biogen Inc. (NASDAQ: BIIB ), The Walt Disney Company (NYSE: DIS ), Fastenal Company (NASDAQ: FAST ), Home Depot (NYSE: HD ), Henry Schein (NASDAQ: HSIC ), J. B. Hunt Transport Services (NASDAQ: JBHT ), LKQ Corporation (NASDAQ: LKQ ), Mednax , 3M Company (NYSE: MMM ), Mettler Toledo International Inc. , Old Dominion Freight Line (NASDAQ: ODFL ), Omnicom Group Inc. (NYSE: OMC ), Penske Automotive Group (NYSE: PAG ), Paychex (NASDAQ: PAYX ), Polaris Industries Inc. (NYSE: PII ), Portfolio Recovery Associates (NASDAQ: PRAA ), Robert Half International Inc. (NYSE: RHI ), Roper Technologies , Ross Stores (NASDAQ: ROST ), Signature Bank (NASDAQ: SBNY ), Snap-On Inc. (NYSE: SNA ), T. Rowe Price Group (NASDAQ: TROW ), Wabtec Corporate (NYSE: WAB ), Whole Foods Market (NASDAQ: WFM ). It is noteworthy that some stocks are present both in FCFPS and EPS Portfolios. These are AZO, MD, MTD and ROP. These companies had the most consistent growth both of EPS and FCFPS. Conclusion. Momentum in earnings is a simple and effective investment idea. Companies that posted profit increases in the past have good potential for growth in the future. A company’s profitability can be described by EPS and FCFPS. The test we conducted shows that the combination of a steadily growing FCFPS and moderate Valuation by P/FCFPS allows is to select securities with higher potential profitability than the combination of a steadily growing EPS and moderate Valuation by P/E.

Best And Worst Q4’15: Mid Cap Growth ETFs, Mutual Funds And Key Holdings

Summary The Mid Cap Growth style ranks ninth in Q4’15. Based on an aggregation of ratings of 10 ETFs and 343 mutual funds. RFG is our top-rated Mid Cap Growth style ETF and CCPIX is our top-rated Mid Cap Growth style mutual fund. The Mid Cap Growth style ranks ninth out of the twelve fund styles as detailed in our Q4’15 Style Ratings for ETFs and Mutual Funds report. Last quarter , the Mid Cap Growth style ranked eighth. It gets our Dangerous rating, which is based on an aggregation of ratings of 10 ETFs and 343 mutual funds in the Mid Cap Growth style. See a recap of our Q3’15 Style Ratings here. Figure 1 ranks from best to worst all ten Mid Cap Growth ETFs and Figure 2 shows the five best and worst-rated Mid Cap Growth mutual funds. Not all Mid Cap Growth style ETFs and mutual funds are created the same. The number of holdings varies widely from 23 to 573. This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Mid Cap Growth style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 (click to enlarge) * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 (click to enlarge) * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Virtus Equity Trust Mid-Cap Core (VIMCX, VMCCX) and the Professionally Managed Portfolios Villere Equity Fund (MUTF: VLEQX ) are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. The Guggenheim S&P MidCap 400 Pure Growth ETF (NYSEARCA: RFG ) is the top-rated Mid Cap Growth ETF and the Calvert World Values Capital Accumulation Fund (MUTF: CCPIX ) is the top-rated Mid Cap Growth mutual fund. RFG earns an Attractive rating and CCPIX earns a Very Attractive rating. The Ark Industrial Innovation ETF (NYSEARCA: ARKQ ) is the worst-rated Mid Cap Growth ETF and the Tocqueville Opportunity Fund (MUTF: TOPPX ) is the worst-rated Mid Cap Growth mutual fund. ARKQ earns a Neutral rating and TOPPX earns a Very Dangerous rating. Lear Corporation (NYSE: LEA ) is one of our favorite stocks held by Mid Cap Growth ETFs and mutual funds and earns an Attractive rating. Since going public in 2010, Lear has grown after-tax profits ( NOPAT ) by 7% compounded annually. The company has maintained NOPAT margins ~5% and currently earns a top quintile return on invested capital ( ROIC ) of 17%. Such strong fundamentals have propelled Lear shares over 20% higher this year, but shares still remain undervalued. At its current price of $125/share, LEA has a price to economic book value ( PEBV ) ratio of 1.1. This ratio implies the market expects Lear to only grow NOPAT by 10% for the remainder of its corporate life. If Lear can grow NOPAT by just 8% compounded annually for the next decade , the stock is worth $174/share today – a 39% upside. CoStar Group Inc. (NASDAQ: CSGP ) is one of our least favorite stocks held by Mid Cap Growth ETFs and mutual funds and earns a Dangerous rating. Despite reporting positive and increasing net income over the past five years, CoStar’s economic earnings have fallen from -$3 million in 2010 to -$131 million on a TTM basis. The company’s ROIC has fallen from 9% to a bottom quintile 1% over this same timeframe. CSGP is up ~3% year-to-date and is currently overvalued given its deteriorating business operations. To justify its current price of $204/share, CoStar must grow profits by 20% compounded annually for the next 19 years. With such lofty expectations baked into the stock price investors would be wise to avoid CSGP. Figures 3 and 4 show the rating landscape of all Mid Cap Growth ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs (click to enlarge) Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds (click to enlarge) Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Blaine Skaggs receive no compensation to write about any specific stock, style, or theme.

3 Small-Cap Growth ETFs For Every Kind Of Investor

Small-cap growth stocks can lead to significant outperformance over time. While the selection of ETFs is comparatively thin, there are several choices for each kind of investor. Healthcare and financials tend to make up the largest positions in these ETFs. I’m primarily a value investor, meaning I look for stocks that the market hasn’t discovered yet or that are out of favor for some reason. So why own a small-cap growth ETF? My favorite asset class is small-cap stocks. That’s because it is where you are most likely to find interesting little companies that other people pass over. They may do something unusual or exotic, and that can scare away most investors. Most of all, however, it is where you are most likely to find the stocks that will outperform the market over the long term. That’s just pure common sense – small companies have much more room to grow to become large companies than large companies have to become, well, even larger. You need a small-cap growth ETF to balance out value with growth, because owning a broadly diversified portfolio is essential. Sector outperformance occurs all the time, and the more diversification you have, the better. If you don’t have diversification, then you risk seeing your overall portfolio fall more in bad times by having your money overly concentrated. A small-cap growth ETF also provides exposure to those fast-growing companies that deliver outsized returns. The small-cap sector can provide outsized returns as well, so the combination of stocks that are growing quickly and have the furthest to run because they are small is what gets me interested in this sector. I’ve been hunting down 3 small-cap growth ETFs to share with aggressive investors, conservative investors, and the average investor. So when it comes to small-cap ETFs, I really like to take my time finding the ones that may suit different investors. There are a lot of approaches to small-cap investing, but here are the three small-cap growth ETFs that I think might be most interesting to the average Joe investor, aggressive investor and conservative investor. The best small-cap growth ETF for the conservative investor is the First Trust Small Cap Growth AlphaDEX ETF (NYSEARCA: FYC ). This is a quasi-actively managed fund. It first narrows down the S&P SmallCap 600 Growth Index by selecting stocks based on growth factors including 3-, 6- and 12-month price appreciation, and sales to price and 1-year sales growth. Value stocks are screened out, and of the growth stocks that remain, the top 75% are selected, which leaves 188 stocks. Those are then divided into quintiles based on their growth rankings and the top-ranked quintiles receive a higher weight within the index. The stocks are equally weighted within each quintile. The index is reconstituted and rebalanced quarterly. The resulting sector breakdown is 28% healthcare, 18% consumer discretionary, 17% financials, 15% IT, 14% industrials, 3.5% consumer staples and a smattering of others. Its P/E ratio averages 23, and has returned a solid 16.64% in the past 3 years. With a beta of 1.06, that return has only come with 6% more volatility than the overall market. The risk-adjusted return is reflected in an impressive Sharpe Ratio of 1.24. The average Joe may consider the iShares Russell 2000 Growth ETF (NYSEARCA: IWO ) is a simple, no-frills ETF. It actually only has 1,158 holdings, in which the fund uses a representative sampling indexing approach, meaning it takes those companies that represent the entire index of 2,000 stocks. It has a reasonable average P/E ratio for a small-cap growth funds, at 26.82, and yet has a beta of only 0.95, meaning it is 5% less volatile than the market. Its yield is 0.68%, which is a pleasant bonus as far as far as I’m concerned since so few small-cap stocks have any yield. That yield covers the 0.25% expense ratio as well. The sector breakdown includes 28% healthcare, 1% energy, 12% industrials, 18% consumer discretionary, 23% IT, 7% financials and 3% consumer staples. Finally, aggressive investors should look at the SPDR S&P 600 Small Cap Growth ETF (NYSEARCA: SLYG ) , which is just about the best-performing fund in this asset class, including better than the S&P 500 index from before the financial crisis to the present. It is like the AlphaDEX fund, but it doesn’t trim out other stocks from the index. It keeps all the growth stocks. The fund holds 355 stocks, spread into 24% financials, 18% healthcare, 17% consumer discretionary, 17% IT, 4% materials, and a bit of other sectors in small amounts. It is the fact that it isn’t terribly diversified in terms of sector allocation that makes it more aggressive. This is somewhat balanced by the fact that the PE ratio is lower than the other choices, at 19.5. Its 1.19% yield pays for the 0.15% expense ratio, giving you that extra 100bps in yield to goose your returns. Its 3-year return is 19.54%, making its more aggressive approach pay off. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.