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Today's "Low Quality" is Increasingly the "High Quality" of Tomorrow. An increasingly prevalent theme is playing out in which "low-quality" companies - those that have poor trailing fundamentals and multiples, and negative analyst revision trends - are "surprisingly" showing improvements. This has driven some double-digit gains in recent months of some "low-quality" stocks, and more recently it seems like we are starting to see numerous single-digit daily moves.

The latest case in point is Allscripts-Misys Healthcare Solutions Inc. (MDRX), up 14.45% for the month to date and up 7.48% Friday.

There have only been six trading days in April so far, and already we have seen double-digit moves in MDRX and other "low-quality" stocks in our model portfolio for the month, such as in MGM Mirage (MGM) and Harley Davidson (HOG) (which we discussed recently), as well as in Arch Coal (ACI) up 10.68%, Petrohawk Energy Corp. (HK) up 12.03$, EOG Resources Inc. (EOG) up 12.73% and Plains Exploration & Production (PXP) up 11.40%.

The Power and Shortcomings of Fundamentally-Driven Quantitative Analysis

On April 2, relative to 3000+ other stocks, MDRX fit the prime definition of a "low-quality" company in our quantitative models. But that all changed on April 7 following the market close. It did not take much - just a ~$4m revenue and $0.01 EPS beat, and slightly raised guidance. As a result, trailing fundamentals and multiples that looked ugly before now look like outliers, and ROIC is set to surge now that it is based off of very easy comparisons to last year. In other words, all it took was a day, and now MDRX now seems trending toward some kind of "higher-quality" label that could even be confirmed by its next reporting date. Some of these other stocks could be anticipating the same.

That many low-quality stocks are moving double digits after such absurdly incremental improvements in reported data and following such simplistic analysis may illustrate a few things: 1) How oversold the market is relative to some normalized fundamental backdrop; 2) How thoroughly petrified sell side analysts have been, just like the rest of the market in general; and 3) the significant level to which this market is driven by quantitative programs, which in turn are probably much less sophisticated than any PhD would admit.

A few other practical things may be also illustrated; 4) It is probably a good idea for fundamental analysts to at least partially integrate simple technical indicators into their work because this can prevent "deer-in-headlights" indecision at key inflection points; 5) Brand name Wall Street firms may not be the first place to seek independent value-added analysis or portfolio management services.

Low-Quality Homework Assignment: Toll Brothers

For those looking for some double-digit moves in the weeks ahead, it may be worth the time to look at a few "low-quality" stocks and see if there are some easy fundamental comps on the horizon. I would start out by looking at Toll Brothers (NYSE:TOL), given that it is on our "focus list" as a low-quality stock, and similar stocks like MGM and HOG have surged recently. Investors may also find it worth some time to look more closely at few other low-quality stocks in our model portfolio strategies as well. Risk-averse investors may want to continue focusing on "high-quality" stocks; a high-quality stock can also do well if it showing improvements and there is less risk involved.

Ascendere Long/Short Strategy Daily Update

'High-quality' stocks in the unlevered long portfolio rose 0.60% and 'low-quality' stocks in the unlevered short portfolio rose 1.17% for the day ended April 9, 2010.

For the MTD [month-to-date], 'high-quality' stocks in the unlevered long portfolio are up 3.26%, ahead of the S&P 500 (ex dividends) at 2.13%. 'Low-quality' stocks in the unlevered short portfolio are up even more for the MTD at 4.76%.

Market Neutral Portfolio

As a result, the Market Neutral Model Portfolio declined -0.57% today and is now down -1.49% MTD.

Moderate Long/Short Portfolio

Given the 120/80 long/short weighting in the Moderate Long/Short Model Portfolio, it declined -0.21% overall for the day. The Moderate portfolio performance is now up 0.09% MTD versus 2.13% for the S&P 500, excluding dividends.

The Moderate Long portfolio is up 3.92% for the month and the Moderate Short portfolio is down -3.72%.

Aggressive Long/Short Portfolio

Given the 200/0 long/short weighting in the Aggressive Long/Short Model Portfolio, it appreciated 1.20% overall for the day. The Aggressive portfolio performance is now up 6.60% MTD versus 2.13% for the S&P 500, excluding dividends.

The Aggressive Long portfolio is up 6.60% for the month.

'High-Quality' Long Stocks Performance

The best daily performers in the long portfolio included Domtar Corporation (UFS) up 4.63%, Macy's, Inc. (M) up 3.80%, and Lubrizol Corp. (LZ) up 2.64%

The worst daily performers in the long portfolio included Credicorp Ltd. (BAP) down -0.85%, Family Dollar Stores Inc. (FDO) down -0.77%, and Tim Hortons Inc. (THI) down -0.74%.

'Low-Quality' Short Stocks Performance

The best daily performers in the short portfolio included Pepco Holdings, Inc. (POM) down -2.41%, EOG Resources, Inc. (EOG) down -2.05%, and Nabors Industries Ltd. (NBR) down -0.75%.

The worst daily performers in the short portfolio included Allscripts-Misys Healthcare Solutions, Inc. up 7.48%, Range Resources Corp. (RRC) up 4.03%, and China Unicom Hong Kong Limited. (CHU) up 3.70%.

Our Long/Short indicator remains strongly net long.

About the Model Portfolio

The Ascendere Long/Short Model Portfolios are "tactical tilt" portfolios that buy the highest quality stocks and sell the lowest quality stocks while maintaining a net long or net short position at all times. They are composed about 80-100 stocks and rebalanced monthly.

Investors focusing on daily moves could find monitoring our model portfolio useful as a proxy for what is working in the market in general as viewed through the lens of "high-quality" versus "low-quality" stocks. 'Back-of-the-envelope' performance attribution is available online.

In addition, daily readers can be apprised to changes in our proprietary long/short indicator, which has been successful at capturing general trends in the market.

Click to enlarge:

Daily-Ascendere-Associates-2010-04-09



Disclosure: None

Source: Allscripts-Misys Healthcare: Yesterday's Low Quality Is Today's High Quality