What are we looking for?
Yesterday, we looked at the Canadian Dangerous Model, a portfolio of stocks whose aim - strictly for demonstration purposes - is to lose as much money as possible. Compiled by CPMS, an equity research and portfolio analysis firm owned by Morningstar Canada, the portfolio has delivered consistently lousy returns over the past couple of decades, but it came roaring back this year.
That's not surprising, given that the recent market rally has been especially kind to low-quality stocks that were driven down to near-death valuations, only to rebound powerfully when the economic doomsday scenario was averted.
Today, we'll look at the U.S. version of the Dangerous Model.
A long-term loser
Since Dec. 31, 1993, the U.S. Dangerous Model has posted an annualized loss of 3.1 per cent, compared with a 6.9-per-cent annualized total return for the S&P 500. To gain entry to the "dangerous" club, a stock must exhibit poor results on seven measures:
- Earnings growth over the trailing four quarters;
- Forward price-to-earnings ratio;
- Earnings surprise - the percentage by which the stock fell short of the consensus earnings estimates for the most recent quarter;
- Percentage by which earnings estimates for the current year (or, once we've entered the fourth quarter, for the upcoming year) have changed over the past three months;
- The ratio of debt to equity;
- The ratio of trailing four-quarter cash flow to debt;
- The ratio of price to book value.
CPMS assigns a percentile score, from 1 to 100, for each of the seven criteria, with 100 representing the stock with the worst reading. CPMS doesn't disclose the weightings applied to each criterion, but it does say they range from 13 to 22 per cent of the total.
What did we find?
The U.S. Dangerous Model posted a 45-per-cent gain this year through Aug. 12, after a 66-per-cent loss in 2008. Even more impressive, the median stock on the list is up 172 per cent from its 52-week low.
But before you go out and buy the most beaten-up stock you can find in the hope of making a big profit, consider that two former members on the list - General Motors and Washington Mutual - never did rebound. GM filed for bankruptcy protection and the assets of failed WaMu were acquired by JPMorgan Chase.
What's more, all of the stocks on the current list are still trading below their 52-week highs, and most have a long way to go before they get back to those levels. As Jamie Hynes, senior account manager with CPMS, says: "It's risky business cherry-picking from this list."