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Reviewing 7 Picks for Conservative Growth Investors

In a recent article ("7 Picks for Conservative Growth Investors"), Seeking Alpha contributor Insider Monkey surveyed seven stocks which he felt fit money manager Martin Zweig's methodology for finding conservative growth stocks. Two commenters raised questions about the article. In this post, we'll consider those questions, and we'll also look at the hedging costs of these seven stocks.

Alan Brochstein's questions

Seeing Alpha contributor Alan Brochstein raised two objections to the article. First, he questioned whether the estimated EPS growth of 59.68% for Intuitive Surgical (NASDAQ:ISRG) was too high. S&P Research and VectorVest agree with Mr. Brochstein on this. Fidelity quotes S&P research as projecting a 1-year forward earnings growth rate for Intuitive Surgical of 16.22%, and VectorVest protects an earnings growth rate for the company of 21% over the next 1-to-3 years.

Mr. Brochstein's second objection was that he didn't consider some of these stocks -- particularly, Intuitive Surgical and SolarWinds (NYSE:SWI) -- to be conservative growth picks. Different investors have different opinions as to what's considered conservative, but the general idea is that conservative stocks should be relatively safer than aggressive stocks. So I though it would be useful to look at VectorVest's Relative Safety Rankings for these stocks.

Recall that Relative Safety is a measure of risk VectorVest calculates based on its analysis of

the consistency and predictability of a company's financial performance, debt to equity ratio, sales volume, business longevity, price volatility and other factors.

VectorVest ranks stocks in terms of Relative Safety on a scale from 0 to 2, with 2 being the highest (BEST) possible score.(to see the VectorVest's Relative Safety ranking for any stock, you can enter its symbol and your email address on VectorVest's home page, and they will email you their analysis of the stock).

Judging by the "fair" Relative Safety ranking VectorVest gave to SolarWind, VectorVest seems to share Brochstein's concerns about the stock. Not so, though, with Intuitive Surgical, which VectorVest considers to have "excellent" Relative Safety.

Xtrayield's question

Commenter Xtrayield questioned whether Insider Monkey accurately characterized Zweig's methodology by describing it as buying stocks with P/E rations greater than 5 but lower than 3x the market average P/E or 43, whichever is lower. According to Nasdaq's Guru biography for Zweig, that is indeed part of Zweig's methodology, but not all of it. In addition to looking for stocks within that P/E range, Zweig looks for

stocks that meet a long host of earnings criteria. Quarterly earnings, for example, should be positive and growing faster than they were (NYSE:A) a year ago, (NYSE:B) in the preceding three quarters, and (NYSE:C) over the preceding three years. Annual earnings should be up for at least the past five years. And sales should be growing as fast as or faster than earnings, since cost-cutting and other non-revenue-producing measures alone can't support earnings growth forever.

Nasdaq also offers a screener where you can find out how closely (to what percent) a stock fits a guru's methodology. In the table below, I've listed these percentages as the "Zweig Rating" for each of these stocks. According to the screener, the stocks Insider Monkey selected do fit Zweig's methodology, for the most part: 6 out of 7 of them have Zweig ratings of 92% or higher.

The table below also shows the VectorVest Relative Safety Scores for all 7 stocks, and the costs, as of Tuesday's close, of hedging them against greater-than-20% declines over the next several months, using optimal puts.

Comparisons

For comparison purposes, I've added the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA) to the table. First, a reminder about what optimal puts are, and a note about decline thresholds; then, a screen capture showing the optimal puts to hedge the comparison ETF DIA.

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, "threshold" refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for each of the securities below.

The Optimal Puts for DIA

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of DIA against a greater-than-20% drop between now and June 15th. A note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true of the other names in the table below).

Hedging Costs and Relative Safety and Zweig Ratings

The hedging data in the table below is as of Tuesday's close, and is presented as percentages of position values. The Relative Safety data is as of Tuesday's close as well. I've added VectorVest's qualitative descriptions ("Excellent", etc.) of the Relative Safety rankings next to the Relative Safety numbers in the table below. The Zweig Ratings are as of Tuesday's close as well.

Symbol

Name

Relative SafetyZweig
Rating

Hedging Cost

ISRGIntuitive Surgical1.46 (Excellent)77%2.80%**
DFSDiscover Financial Services0.86 (Fair)92%4.31%**
ICEIntercontinental Exchange0.89 (Fair)100%2.31%*
QSIIQuality Systems, Inc.1.29 (NASDAQ:GOOD)100%7.16%*
SWISolar Winds1.03 (Fair)100%6.81%*
CSHCash American International1.2292%5.88%*
BWLDBuffalo Wild Wings1.35 (Very Good)92%4.04%*
DIASPDR DJIA1.00 (Fair)NA0.99%*

*Based on optimal puts expiring in June

**Based on optimal puts expiring in July

Source: Addressing Questions About 7 Conservative Growth Picks