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Top 30 Stocks From The S&P 500 For A Balanced And Conservative Portfolio

Over the past three months, I have developed a Stock Relative Scoring System (SRSS) – a system to grade stocks inside a selected universe, based on 46 parameters, grouped into seven categories, plus dividend scoring as a separate category with 13 additional parameters.

The System is based on three main categories:

  1. Growth
  2. Value
  3. Profitability and Quality

The Growth Score depends on compounded annual growth rates (CAGR) of revenue, operating income and net income from continuing operations, measured over five and three-year long periods. Additionally, the System considers the consensus of analysts' estimates of long term projected net income growth.

The Value Score is calculated from parameters such as, trailing 12 months P/E, forward P/E and P/FCF (free cash flow). I am also calculating EVA (economic value added) for every stock and use an EVA/P ratio, which I call EVA yield. Finally, due to the increasingly recognized importance of ROIC (return on invested capital), the price of which is best measured with the EV/IC (enterprise value to invested capital) ratio, I have included those two parameters as well. (Including EV/IC and ROIC into the mix has the net effect of including EV/NOPAT ratio, as ROIC=NOPAT/IC.)

The Profitability and Quality Score is calculated from a total of 13 parameters, which include the gross, EBITDA and net margins, the margin trends, ROIC, ROA (return on assets) and ROE (return on equity), as well as trends in calculated rates of return. Finally, this Score considers the accrual ratio. As some authors have demonstrated that the ROIC is the most important measure of a company's profitability, SRSS assigns an overweight participation of ROIC in the Profitability and Quality Score.

These three main categories (Growth, Value, Profitability and Quality) are the main drivers behind the SRSS and are used to calculate the Main Drivers Score.

Four additional categories of the System are used as corrective factors:

  1. Liquidity and Solvency
  2. Stock Price Momentum
  3. Stock Trading Risk
  4. Fundamental Momentum

The Stock Price Momentum Score is calculated from a stock's price change in the last 3 months and in the last year, plus the ratio of the current stock price to its 200-day moving average.

The Stock Trading Risk considers the maximum drawdown that the stock has experienced over the past five years (calculated from a monthly series of stock prices), RoMaD (return over the maximum drawdown) and the Sortino ratio.

Finally, Fundamental Momentum considers how many consecutive times the company has beaten their earnings and consensus estimates, counted backwards three years from their latest quarterly report. It also considers average surprises and the count of positive quarterly EPS. A positive EPS count is needed in order to make the important distinction between companies, which beat expectations due to actually making more money than expected, and those which are, unfortunately, only beating consensus projections by burning through cash slower than the analysts expected.

Dividend scoring is a completely separate part of the SRSS and will be introduced in one of the next articles.

Balanced and Conservative Long Strategy

In this article I am going to introduce the Balanced and Conservative Long Strategy, apply it to the S&P 500 constituents and present the top 30 list.

Stocks are ranked by their Main Drivers Score, with the worst 20% market performers excluded, along with the companies with the worst Fundamental Momentum. As this strategy is conservative, I have also eliminated the bottom 40% of companies by their Stock Trading Risk Score, meaning those which experienced above-average drawdown and negative volatility over the past five years.

For this portfolio strategy we are going to ignore debt levels, as in the low interest rate environment, which the US economy has been enjoying (and is expected to continue to do so), indebtedness does not represent one of the main concerns that I look for when analyzing a company. Nevertheless, in case you do not share this opinion, I have included the Liquidity and Solvency Score into the list, for informative purposes.

As with all quick picks, which by their nature exclude a thorough insight into individual companies in the list, investors are strongly advised to do additional research before allocating a significant amount of their capital to any of the following stocks.

That being said, here is the top 30 list from the S&P 500 stocks, by the Balanced and Conservative Strategy.


Top 30 S&P 500 stocks

For a faster glance to determine where strengths and weaknesses of each of the stocks lie, here is a color-coded representation of grades awarded to individual scores.


Top 30 stocks S&P 500, grades

Let us now take a closer look at the top 10.

Lam Research Corporation (LRCX)


With strong CAGRs of revenue, as well as operating and net income, both over the 3-year and 5-year periods, LRCX is in the 97th growth percentile among the S&P 500 stocks. Profitability rates ROIC, ROA and ROE stand at 20.8%, 18.2% and 41.4%, respectively, and have all increased when compared to 5-year averages. Gross, EBITDA and net margins stand at 45.1%, 28.5% and 22.4%, respectively, and seem very consistent. Lam Research has delivered at least 12 consecutive positive EPS surprises (as I don't calculate EPS surprises for periods prior to the last three years), with the average quarterly EPS beating consensus estimates by 7.1%. While not being cheap, the Value Score is decent at 73. With their Main Drivers Score at 99.3, LRCX sits at the top of this list.

Booking Holdings Inc. (BKNG)


BKNG is the second weakest stock market performer in our top 10 list. With its 1-year return of 19.2%, BKNG has strongly underperformed the broad market. BKNG financials show that it is a high-growth, highly profitable company, which is undervalued vs their sector and industry peers in the S&P 500. While capitalization-weighted Consumer Discretionary companies trade at 28.4 trailing 12 months P/E, and Internet & Direct Marketing Retail companies trade at 58.1, BKNG trades at a comparably modest 19.8 P/E.

With 5-year revenue, operating income and net income CAGRs at 16.4%, 17.0% and 16.1% respectively, BKNG scores 93 points for growth. The profitability rates of ROIC, ROA and ROE stand at 23.4%, 19.0% and 54.6%, respectively, which along with strong margins of 38.8% and 29.0% for EBITDA and net margin, respectively, yields a Profitability and Quality Score of 98.5. In addition, BKNG has beaten analysts' consensus EPS estimates by an average of 8.4% in the past 12 quarters. With their Main Drivers Score at 99.1, BKNG is number two on this list.

NVR, Inc. (NVR)

This homebuilder scores highly on all three Main Drivers Scores. Interestingly enough, it is followed by less than 5,000 people on Seeking Alpha, despite returning 54% over the past year, and being a large cap stock with above 10% revenue CAGR and a 24.5% net income CAGR (for the 5-year period, 27.7% for the past three years). At trailing 12 months P/E at 16.8 it does not seem expensive, either. Profitability is strong, with ROIC, ROA and ROE at 28.8%, 24.7% and 42.2%, respectively. All three return rates have increased against their 5-year averages. Margins are also healthy, with gross, EBITDA and net margins at 21%, 14.3% and 11.5%. Like the return rates, all margins are improving when compared with their 5-year averages.

NVR's fundamental momentum is fairly young when compared to Lam Research, with only four consecutive quarters of beating consensus EPS estimates. However, analysts are constantly underestimating NVR's earnings. (This is an understatement. In fact, they are failing miserably.) In the past 12 quarters, NVR has delivered an average surprise of +13%. NVR has a Main Drivers Score of 98.9 and is a strong candidate for a long-term portfolio.

The Progressive Corporation (PGR)

In fourth place on our list is the only financial company in the top 10. At 14.1 trailing P/E, PGR is valued at an average level for the Insurance industry. As other companies in the Balanced and Conservative list, PGR is characterized by profitability rates, growth rates and margins that are both high and strong. In the past 12 quarters, PGR has delivered an average EPS surprise of +8.7%.

Intel Corporation (INTC)

Number five on our list, Intel, has also been growing at very healthy rates, albeit not as quickly as the top four companies in the list. What Intel doesn't have in growth, is made up for by healthy margins and strong return rates (on invested capital, equity and assets). Intel trades at a heavy discount vs both the IT sector and Semiconductors industry peers, at 13.3 P/E vs 29.3 and 24.1 for the sector and the industry, respectively.

Additionally, Intel has been leaving analysts' estimates trailing in its dust over and over again, by beating EPS consensus projections in every single quarter over the past 3 years, while delivering an average +12.8% surprise.

Applied Materials, Inc. (AMAT)

Next on the list of the top 10 S&P 500 stocks for a Balanced and Conservative portfolio is Applied Materials, Inc. Even after returning 85.3% over the past year, at a 21.3 trailing P/E ratio, AMAT is trading at a mild discount vs the sector (IT) and industry (Semiconductors) peers. Return rates for ROIC, ROA and ROE stand at 19.3%, 14.8% and 35.9%, respectively. Revenue, operating income and net income CAGRs stand at 10.0%, 16.5% and 20.3% for the past 5 years, although it should be noted that net income CAGR has slowed down to 16.3% for the past 3 years. Gross, EBITDA and net margins are exceptionally stable at 43.7%, 25.4% and 18.5%. Like LRCX and INTC, AMAT has been beating consensus EPS estimates for at least 12 consecutive quarters, while delivering a more modest average surprise of +3.9%.

PulteGroup, Inc. (PHM)


PulteGroup's main strength is its valuation, followed by growth, while the Profitability and Quality Score is, admittedly, the lowest among the top 10 stocks. The stock has returned 57% over the past year. Like LRCX, INTC and AMAT, PHM has beaten the EPS consensus 12 times in the row, while delivering a very high average surprise of +10.5%. Trading at 12.3 P/E, PHM is offered at a mild discount to its Household Durables peers, which on average trade at 14.7.

Masco Corporation (MAS)


The most interesting thing about Masco is that they have had negative common equity on their balance sheet since 2015, but not because of losses (as the company has been consistently profitable), but because of their persistently aggressive stock buyback program. With other parameters being healthy, this company scores a combined Main Drivers Score of 96.4 and is number eight on our list.

Lockheed Martin Corporation (LMT)

This global Aerospace and Security company boasts an "insane" return on common equity of 247%. Healthy growth and margins, along with a modest price discount vs peers and with an average EPS surprise of +9%, lead to the strong Main Drivers Score Score of 95.7 and positions LMT in 9th position among the S&P 500 stocks for the Balanced and Conservative portfolio.

UnitedHealth Group Incorporated (UNH)


Despite strongly underperforming the S&P 500 and delivering a return of only 16.8% over the past year, UNH is a company that has to be considered for a long-term conservative portfolio. The company constantly shows excellent growth, has been delivering a positive average EPS surprise of 3.9% and is moderately undervalued against sector and industry peers. UNH’s trailing P/E ratio currently stands at 19.9, vs 26 for the Healthcare sector and 23.7 for the Healthcare Providers & Services industry.

Conclusion

All values in this article are sourced either directly, or through calculations, from the S&P Global Market Intelligence, as provided by Finbox, and they reflect market prices as of the markets' close on January 21st 2020.

I intend to come back to this portfolio of 30 stocks (equal weighted), to evaluate its performance. In the following days and weeks, my plan is to follow up with a number of articles, in which I will recommend portfolios of stocks selected by other criteria, such as dividend yield and/or growth, value picks, strongest growth at reasonable price, etc. If you have a specific wish, on which group (sector, industry, size, something else) of stocks you would like to see analyzed, please let me know in the comments.

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