What are we looking for?
Stocks trading in the United States that look like they may be headed downwards.
More about today's screen
We performed this exercise on Canadian stocks a week ago with the help of Morningstar CPMS, an equity research shop. It has what it calls its "dangerous" portfolios, in which it identifies stocks with declining earnings and earnings expectations, high valuations and high debt. More specifically, today we'll screen for the worst U.S. stocks for:
-earnings growth over the past four quarters;
-price to expected earnings for the upcoming year;
-ratio of debt to equity;
-ratio of trailing four quarters' cash flow to debt;
-negative earnings surprises for the most recent quarter;
-three-month revision of earnings estimates.
CPMS senior consultant Craig McGee created a portfolio of companies that have a market cap greater than $500-million (U.S.) and which hold long-term debt. The worst 20 are shown in the table.
More about CPMS
CPMS is an equity research and portfolio analysis firm owned by Morningstar Canada. It maintains a database of about 680 of the largest and more liquid Canadian stocks, plus more than 2,100 U.S. stocks, and spends a lot of time adjusting for unusual accounting items in each company's quarterly results to make sure screens can perform correctly.
What did we find out?
Mr. McGee looked back to 1993 and found that a 40-stock portfolio using these characteristics produced a total loss of 1.3 per cent annually including dividends, compared to a 7.6-per-cent gain for the S&P 500 total return index. This year, the portfolio is down 17 per cent, versus the S&P 500 total return, which is down 2.5 per cent.
"We use these criteria to identify companies with relatively poor fundamentals," Mr. McGee said. "It's designed to raise a red flag so you can take a closer look at why you're holding or watching those companies. These types of highly levered firms with deteriorating fundamentals tend to get punished with rising market uncertainty. On the other hand, these stocks may also experience a sharper comeback if markets charge forward."
Notes to accompanying table
* Percentage change of the latest four quarters operating EPS vs. the four quarters of operating EPS one quarter ago.
Grades relative to 2,195 U.S. stocks in the CPMS universe (A: best, E: worst).
Source: Morningstar Canada
Scott Adams