I recently made changes to the Dugan Scoring System and presented it here on SA. Most of the changes were suggested by SA readers. The result is a more comprehensive rating system of David Fish's CCC stocks. For an explanation of the CCC lists click here.
If you read the above reference explaining the Dugan Scoring System, you know its purpose is to identify stocks on the CCC lists which are excellent all-around stocks with solid current conditions and excellent future expectations. The scoring system rates stocks on 13 performance variables across 4 major categories: Risk, Value, Past Performance and Future Performance Expectations. When scoring stocks on many performance variables to identify those which are best (by highest score) to consider for due diligence and possible purchase, it naturally occurs that those with the lowest scores fit the definition of "worst." In this case, best and worst are relative, not absolute, terms. A good company's stock could fall into the "worst" category for further due diligence by virtue of it being overvalued and in an out-of-favor sector or industry. So, please don't take offense if one of your core equities or recent purchases is labeled "worst" because it didn't score well in this exercise.
Below, you can see a table which illustrates the 15 lowest-scoring companies, after filtering for criteria I believe SA readers would value. Those criteria are
- Minimum 8 years on the CCC list (meaning they increased their dividend even through the great recession)
- Minimum $10B market cap (making them large-cap equities)
- Minimum yield of 2.5%, because I think most (not all) SA readers lean toward stocks with a decent yield
Additionally, for this article, I added 1 more twist to the scoring system. In many SA and other articles, I read suggestions about which stock sectors are in- and out-of-favor for the foreseeable future. One notable source is Fidelity's Quarterly sector update, printed below:
To adjust the earned Dugan Score to allow for whether a sector is currently favored or unfavored, I simply took the net of "+" and "-" signs, multiplied by 2 and added to, or subtracted from, the 2016 Dugan Score. For instance, Technology has 5 plusses and no minuses, thereby earning an additional 10 points for each Technology stock. Energy has 3 minuses and zero plusses, thereby earning a reduction of 6 points for each stock. Consumer Discretionary has 3 plusses and 1 minus, thereby earning an additional 4 points ((3-1) times 2).
Here are the post-filtered, worst-scoring 15 companies (showing both the 2016 Dugan Score and the score having been adjusted for sector favorability):
The lowest scoring stock, including sector favorability/unfavorability adjustments, which survived the filtering process is Kellogg (NYSE:K) with a score of only 27 points, out of a possible 150 (without adjustments). That compares to a highest score of 127 points and an average score for the 673 CCC companies of 70.
Let's take a quick look at Kellogg to see why it scored so low. Using the table above, we can see its most recent dividend increase is a low 2%, its payout ratio is high and it appears to be overvalued by relative Graham number. Estimated EPS growth for this year is negative, while EPS growth for next year and 5 years out are a paltry 5% and 4% respectively. Plus, K's DGR history for the 4 time periods shown is rather poor.
So, now let's also take a look at FASTGraphs to see if there is corroboration of K's poor Dugan score. When looking at the graph below, K appears to be overvalued by about 21% on a P/E basis. While acknowledging K's investment grade credit rating of BBB and reasonable debt/equity ratio of 54%, we can't overlook its 10-year operating earnings growth rate of only about 4% and its profit decline of 8% in 2015, all of which explain the low DGR history.
Moving on to the future, the 22 and 13 analysts for 2016 and 17, respectively, are forecasting EPS growth of only 5% in 2016 and a reasonable 8% in 2017. Analysts have a 1 and 2-year success rate of accurately forecasting earnings of 100% (see red circle on the image below). A final note from the graph below: while K is overvalued now, if it reverts to its normal P/E of 16.9 ish by year end 2017, investors will experience a rate of return of negative 1.84%, including dividends, from now until then (see rectangular box and dotted line in the graph below).
I hope you enjoyed this journey. Comments are encouraged. Happy investing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. (Stolen from Chuck Carnevale.)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.