Mid-June 2016 Update: Dugan Stock Scoring System Recent Buys Continue To Massively Outperform The S&P 500

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Includes: ABBV, ADM, BBY, CMI, PRU, TROW, VLO, WRK, XOM
by: Dennis Dugan

Summary

The Dugan Stock Scoring System (DSSS) is designed to identify high-quality stocks that will outperform the market.

In its fourth real monthly test, DSSS-selected stocks again blew away the S&P 500 and again further increased the outperformance.

Is this result a fluke or a harbinger of great things to come? Stay tuned!

I can't emphasize enough that the outperformance will come back to earth before the year is over. But, the ride so far sure is fun (and profitable).

Last spring, I created the Dugan Stock Scoring System (DSSS) for David Fish's All-CCC stocks (about 685 long-term dividend paying stocks (non-REIT and non-MLP) with histories of raising dividends for a minimum of 5 years to over 50 years). You can find David's CCC list here. Click on the "Excel Spreadsheet" link in the U.S. Dividend Champions section. Alternatively, you can type in his name in the "search by" box in the upper right corner of any SA page and "follow" David and you will then receive a notice each month when he publishes the CCC list.

I introduced the stock scoring system in a Seeking Alpha article on 8/21/2015. Toward the end of 2015, I made some formula changes, most of which were suggestions that came from SA readers.

The Dugan Stock Scoring System is a tool to identify the overall quality of CCC companies. Those companies' stocks earning high Dugan Scores are high quality stocks which should produce better investing results, going forward, than otherwise would be attained by simply filtering for desired characteristics. In this context, highest quality means companies which have:

STRONG CURRENT CONDITIONS, as exemplified by: great value as measured by relative Graham number, low payout ratio, low debt/equity ratio and high Most Recent dividend increase % EXCELLENT FUTURE PROSPECTS, as exemplified by: high EPS growth forecasts for This Year, Next Year and 5 years out, and excellent dividend growth histories.

DSSS isn't a popularity contest. It is a disciplined, systematic and dispassionate approach that evaluates each CCC stock on the basis of a wide variety of investment criteria from four broad categories: Risk, Value, Past Performance and Future Performance Expectations. So, the purpose of the Scoring System is to determine the all-around quality of a stock for buying, holding or selling purposes. No stocks, like no people, are perfect. Therefore, even high quality and high scoring stocks have weaknesses. So, a Dugan Score is a balanced, holistic picture of a stock, which includes its strengths and weaknesses.

You can see from the above explanations, the Dugan Stock Scoring System calculates a score based on the current state, and expected future performance, of a company's stock; not necessarily the company itself. And, it doesn't matter how well a company's stock has performed for its owners in the past. What only matters is the current condition and expected future performance of the stock.

The table below is a summary of the metrics used in the Dugan Scoring System, along with each metric's relative weighting in the overall formula. The weightings are my assessment of each metric's relative importance in calculating the company's overall quality.

DSSS june 2016

I have recently made a few changes in the scoring system. The primary change is to limit the maximum achievable score to 100 points, versus the previous 150. I did this to give Dugan Scores a familiar and understandable frame of reference for SA readers. Suffice to say, the changes did not have a material impact on which companies scored high or low.

An additional change to the scoring system is a small bonus, or penalty, applied to the earned-score for each CCC stock and based on a few brokers' recommendations for sector weightings. The base bonus or penalty calculation is simple: market weight earns zero points, overweight earns 1 point, underweight earns minus 1 point.

Examples: IT earns 3 bonus points because each of Ned Davis, S&P Capital IQ and Fidelity recommend overweighting IT; utilities earns minus 1 point because of 2 underweights and 1 market weight; CS earns 0 points because of 3 market weight recommendations. You can find the Fidelity article wherein the weightings recommendations are presented here.

They are summarized in the following table:

Weighting Recommendations

Sector

Fidelity Market Weight 05/13/2016

S&P Capital IQ05/13/2016

Research (PDF)05/16/2016

Information Technology

19.78%

Overweight +0.40%

Overweight

Financials

15.94%

Marketweight

Marketweight

Health Care

14.59%

Overweight +0.30%

Underweight

Consumer Discretionary

12.94%

Overweight +0.30%

Overweight

Consumer Staples

10.47%

Marketweight

Marketweight

Industrials

10.11%

Marketweight

Marketweight

Energy

7.12%

Underweight -0.80%

Marketweight

Utilities

3.43%

Underweight -0.20%

Marketweight

Materials

2.91%

Marketweight

Marketweight

Telecommunication Services

2.71%

Marketweight

Marketweight

Click to enlarge

Every month I apply the scoring system to David's "All CCC" spreadsheet. After scoring all 750 or so companies, I eliminate REITs and MLPs, then throw out the bottom-scoring 50%, leaving 350+ companies which are the best-of-the-best. I then filter those 350 companies by characteristics which I believe align well with SA readers' needs.

The filters might include:

  • Minimum 8 years on the CCC list
  • Minimum $3 to $10B market cap.
  • Maximum relative Graham number of 80.
  • Maximum payout ratio of 70.
  • Minimum most-recent dividend increase of 6%.
  • Minimum estimated EPS growth next year of 6%.
  • Minimum estimated EPS growth for the next 5 years of 6%/year.
  • Minimum yield of 2.3%

The result of filtering those best-of-the-best CCC stocks is a list of +/- 15 companies that have strong current conditions, excellent future prospects and have been filtered for characteristics which I value. The difference between my system and a usual filtering process is I only filter companies which are high quality and whose strengths far outweigh their weaknesses. I believe this difference will produce better investing results, while still meeting my individual requirements.

I present those 15+ stocks to SA readers for them to consider as possible purchase candidates. The articles which present those lists usually carry titles like "May's top 15 CCC companies" or "April's top large-cap CCC companies." They can be found by searching for my name in the search box in the upper right corner of the SA site.

This process is what I use to guide my own investing buying and selling.

Believing in the efficacy of the DSSS to identify excellent companies to purchase, in January and early February of 2016, I bought significant dollar amounts of 9 stocks. All 9, except AbbVie (NYSE: ABBV), are stocks which came from recent "top 15 stocks" lists in my "Best of …" series of articles, mostly in December. Those 9 stocks are the only ones I've purchased in 2016, except for a very recent purchase of Valero (NYSE:VLO).

A few months ago, I did a quick analysis to see how my actual purchases had performed relative to the S&P 500. As of the first check, my actual purchases had outperformed the S&P 500 by a whopping 52%. One month later, I did the same comparison and the outperformance had increased to 73%. When I did the May 2016 update, the outperformance had increased again to 123%. And, now, for the mid-June update the outperformance jumped yet again to almost 135%. Here is the table with the numbers:

june performance comparison to s&p 500 Click to enlarge

Asterisk from Westrock, above. Recently, WRK spun off part of itself into a separate publicly-traded company called Ingevity Corporation (NYSE: NGVT). To calculate the 18.1% gain, I added the current market value of my positions in WRK and NGVT, and divided by my original cost of WRK.

As said a month ago, I realize that 9 stock purchases is too small a sample set and that 5 months of relative performance is too short a time to draw firm and final conclusions. But, I'm very happy with the significant outperformance so far. And, I'll again report progress on these 9 purchases later in 2016.

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. (Borrowed from Chuck Carnevale.)

Disclosure: I am/we are long XOM, ABBV, WRK, BBY, TROW, CMI, PRU, ADM, VLO.

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.