Every month, I use the Dugan Scoring System, and what I think are meaningful filters for SA readers, to determine the "best" and "worst" of David Fish's All-CCC companies for that month. In recent days I have reported April's best all-around CCC stocks and April's best 3 stocks in each market sector. For this article, April's "worst," the filtering criteria are:
- Minimums of $10B market cap and 2.3% yield, making them large-cap equities with decent yields
- Minimum 8 years on the CCC list, which means the dividend was raised even through the great recession.
The Dugan Scoring System is a tool to identify the overall, relative, 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. When one scores and ranks stocks looking for the best, it follows that it is easy to also identify the worst, by quality. In this context, the "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.
The "worst" stocks would therefore have weaker current conditions and/or poorer future prospects. Those are both relative terms.
The Dugan Scoring System 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. The purpose of the Dugan Stock Scoring System is to determine the all-around quality of a stock for buying, holding or selling purposes.
You can see from the above explanations, the Dugan Scoring System is about 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 following 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.
At any point in time, every company is a balance of strengths and weaknesses. Since no company is perfect, every company has some of each. Same for every person, by the way. The strengths and weaknesses come from both internal and external (market) sources. The company's stock may or may not accurately reflect those strengths and weaknesses.
The Dugan Stock Scoring System assigns values (scores) to many current condition and future prospect variables, and calculates the sum. The net sum of those plusses and minuses for each company, when compared to the same for all other companies, establishes a company as, relatively, either strong (top half of Dugan scores) or weak (bottom half of scores). Strong companies have, on balance, solid current conditions and excellent future prospects. Weak companies may have some of each of those, but not enough to qualify as candidates for buying, or maybe even for holding.
Here are the post-filtered, worst-scoring 20 companies:
There are some iconic names on the list of worst companies. Many of them have been on the CCC list for decades and most are large companies with widely held stocks. These characteristics usually elicit some backlash when the "worst" lists are published each month. That's ok, because it causes us all to do some critical thinking about our holdings. Causing that thinking is part of the reason I write the "worst" articles, and endure some caustic comments. That's true for why I write the "best" articles, also.
In my mind, the reasons any stock qualifies for the "worst" list are quite obvious if one takes the time to look at the individual company's metric performance as evidenced in each column in the CCC table. And, that performance doesn't necessarily mean they are bad companies. It could simply mean they are greatly overvalued and thus have earn zero points for "value" in the scoring system. But, it usually also means their dividend growth history is relatively poor in any or all of the most-recent, 1, 3, 5 or 10 year periods; or EPS growth is forecasted to be poor for this year, next year or 5 years out; or payout ratio is high (maybe because of a one-time, non-cash write off of an underperforming asset) or debt/equity ratio is too high. So, if one of your core positions is on the list, please take a look at its relative performance in each those important areas. I'm not suggesting selling any stock on the list. But, I am suggesting that there are better stocks on the CCC list to own over the next few years than those whose stock metrics caused it to land on the list. Again, it doesn't matter how iconic the company is, or how well it has done for its owners in the past. What matters is its current condition and future performance expectations.
Let's take a quick look at the Clorox Company (NYSE:CLX) to see why it landed on the list. I chose CLX because it is iconic, is widely held, is popular among SA readers and has a very long history of performing well for its owners. Using the table above, we can see its most recent dividend increase is a low 4.1% and its payout ratio is about average, but its valuation, from both a P/E and a relative Graham number basis, suggests it is way overpriced. These characteristics alone could account for its low Dugan score and inclusion on the list.
CLX's dividend growth history is relatively poor and in decline from 5 to 3 to a 1 year basis. The dividend growth history is fully explained by CLX's modest EPS growth over the same period. However, analysts appear to be forecasting a jump to a more respectable 7% average annual EPS growth over the next 5 years. CLX's D/E ratio on the CCC list is just too high to be believable so one would have to corroborate that from another source. A little disturbing is that the dividend has been raised 175% faster than earnings over the past 5 years. With a current payout ratio of 62%, future dividend increases will have to align better with earnings increases. So, the 7% forecast doesn't have much slack built in.
So, now let's also take a look at FASTGraphs to see if there is corroboration of why CLX received a poor Dugan score. When looking at the graph below, CLX appears to be as overvalued as it's been for the last 20 years, by about 28% on a P/E basis. That alone causes CLX to earn zero points out of a possible 40 points for valuation in the Dugan Scoring System.
Moving on to the future, there are 16 analysts for 2016 and 17. Looking at the dotted line and the inserted box in the FASTGraph below, if CLX returns to a normal valuation of P/E at 21 by fiscal year end (June 30th) 2017 it would return an annual loss of 8.64% between now and then.
All this information suggests now is not a good time to initiate a new position in CLX. But, it doesn't necessarily suggest selling CLX. Current holders might be happy with the 2.4% yield rather than key a capital gains tax.. This is the paradox with otherwise good companies that become overvalued. But, if CLX is in an IRA, there are better CCC options available for the next 2 years.
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 PG.
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.