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WHAT ARE WE LOOKING FOR?

Yesterday, we looked at CPMS Computerized Portfolio Management Services Inc.'s model portfolio of the lowest-quality TSX stocks, called the CPMS Dangerous Model Portfolio. Today, we examine the U.S. version of the portfolio.

CPMS's rationale is that stocks with weak financial fundamentals tend to underperform, and should generally be avoided. More than 20 years ago, it devised the Dangerous Model Portfolio to help its clients weed out the Canadian market's poorest-quality stocks. It introduced a U.S. version of the portfolio in 1993.

THE METHOD

The U.S. Dangerous Model Portfolio contains the 40 lowest-quality stocks from the more than 2,400 CPMS tracks in its database. Companies must have a market capitalization of at least $500-million to be included. (For the purposes of this column, we feature the 20 biggest stocks in the portfolio.)

The portfolio components are determined using many of the same measures as the Canadian version, including:

Trailing four-quarter earnings growth;

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.

But the U.S. version goes a step further, also ranking each company's performance relative to the median for its industry group for the following criteria:

Forward 12-month price-to-earnings ratio;

Earnings surprise, i.e. the percentage by which the stock fell short of the consensus earnings estimates for the most recent quarter;

Earnings growth;

Debt to equity;

Cash flow to debt.

THE RESULTS

On a total-return basis, the U.S. Dangerous Model Portfolio has posted an annualized return of 3.2 per cent since its inception at the end of 1993, well below the S&P 500's 11.1 per cent. Over the past three years, the Dangerous portfolio's annualized returns are 1.7 per cent, compared with 13.2 per cent for the S&P 500.

The underperformance has been even more pronounced in the nearer term, as uncertain markets have fuelled a flight to quality. The Dangerous portfolio has lost 13.4 per cent in November (S&P 500 down 5 per cent), 15.8 per cent in the quarter to date (S&P 500 down 3.5 per cent) and almost 30 per cent in the year to date (S&P 500 is up 5.4 per cent).

CPMS U.S. Dangerous Portfolio
Rank Variables relative to industry peers**
1= US$ Debt Cash 3-mo % * Debt Cash % * %
lowest Price to flow % chg in Earnings to flow Earnings Earnings
quality Ticker Company name Nov. 28 equity to debt EPS est. growth equity to debt P/E growth surprise
1 LXP-N Lexington Realty Tr. 17.53 2.95 0.04 -75.00 -100.00 4.68 0.20 n/c -100.71 -75.00
2 FUN-N Cedar Fair LP 23.74 4.92 0.12 -20.00 -66.78 10.74 0.27 1.27 -67.72 -65.92
3 CFC-N Countrywide Finan. 8.72 4.66 -0.24 -32.18 -85.00 7.39 -1.25 0.32 -85.71 -65.46
4 LPX-N Louisiana-Pacific 14.30 0.33 0.12 -62.67 -45.08 0.66 0.25 n/c -47.97 -9.84
5 HGSI-Q Human Genome Sci. 9.95 10.80 -0.25 -35.53 -2.42 53.54 -0.76 n/c -6.35 -5.08
6 REGN-Q Regeneron Pharma 17.15 1.32 -0.43 -29.85 -3.23 6.55 -1.29 n/c -7.15 -16.43
7 PPS-N Post Properties Inc. 36.50 1.07 0.06 0.00 -50.65 1.70 0.33 8.14 -51.36 -10.65
8 FHN-N First Horizon Nat'l 22.00 2.81 0.00 -30.47 -27.23 4.45 -0.02 0.95 -27.94 -16.67
9 USG-N USG Corp. 37.37 0.58 1.02 -81.11 -38.14 1.73 1.65 13.91 -42.12 -4.51
10 ALU-N Alcatel-Lucent 7.83 0.32 0.44 -31.51 -80.65 37.00 0.19 0.66 -84.20 -52.93
11 RHD-N RH Donnelley Corp. 42.50 5.06 0.07 -11.79 -22.02 11.03 0.15 1.48 -22.96 -5.09
12 FRE-N Freddie Mac 29.42 18.36 0.02 -76.13 -5.59 29.09 0.09 1.73 -6.30 -2.84
13 VHI-N Valhi Inc. 19.57 1.32 0.14 0.00 -25.42 3.94 0.23 1.85 -29.40 -12.70
14 EXEL-Q Exelixis Inc. 8.70 1.18 -1.19 -3.33 -2.77 5.84 -3.60 n/c -6.70 -4.95
15 HR-N Healthcare Realty Tr. 25.19 1.21 0.13 0.00 -22.06 1.91 0.66 2.41 -22.77 0.00
16 JOE-N St Joe Co. 28.11 1.14 -0.26 0.00 -5.05 1.81 -1.34 3.13 -5.76 -3.39
17 CUZ-N Cousins Properties 23.94 0.94 0.07 0.00 -12.05 1.48 0.36 7.05 -12.76 -2.05
18 GAP-N Great A & P Tea Co. 30.06 0.56 0.36 13.71 -22.18 1.03 0.74 n/c -25.71 -1.52
19 OFC-N Corpor. Office Prop. 35.25 2.16 0.08 0.00 -0.39 3.42 0.43 4.89 -1.10 -3.50
20 PMCS-Q PMC-Sierra Inc. 7.31 0.39 0.04 27.27 -15.90 44.99 0.02 1.24 -19.45 -2.63

* percentage change of the latest four quarters operating EPS vs. the four quarters of operating EPS one quarter ago

** percentage variation from the industry median

SOURCE: CPMS

dparkinson@globeandmail.com

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