(By Rich Bieglmeier) In a recent white paper, Perkins Investment Management found "high-quality securities have offered more consistent returns with less risk and greater compounding efficiency" than their low-quality counterparts.
The research focuses on how beta can distort stock selection using the Capital Asset Pricing Model (CAPM). In a nutshell, CAPM calculates the required rate of return needed to compensate for the risk taken relative to the S&P and the risk-free rate i.e. short-term US treasuries.
Beta is a measurement of risk/return relative to the S&P, with one being equal to the index. As a rule of thumb, anything under one is considered to be less risky and more than one more risky. So, a stock with a beta of three would be expected to move 3% for every 1% the S&P moves in either direction.
Perkins found that the beta component of CAPM identifies too many low-quality stocks as potential buy candidates. The investment management firm concludes that investors take on more risk and generate less return as a result. Now that's bass ackwards.
The paper defines high quality stocks as those with the best debt/equity scores, interest rate coverage, predictability of EBITDA from the previous trailing 12 quarters, percent of quarters of EBITDA increases from trailing 12 quarters, industry rank for Return on Assets (ROA), and percent of quarters ROA in top third of industry group over trailing 12 quarters.
We broke out the trusty screener, once again, to identify the "highest quality" stocks with the highest betas.
Based on our take of Perkin's findings, the stocks that get spit out as qualifiers should offer "more consistent returns with less risk and greater compounding efficiency." In other words, make you more money with less risk.
The first thing iStock did was screen for companies that trade an average of at least $500,000 a day. No matter the quality, you'll need some liquidity to get in or out in a mad rush – result 3848 possible stocks.
Next up, we queried for companies in the top 50% as ranked by the previous 12 month's debt/equity ratios – result 2530 possible stocks.
ROA was next, with an average of 12.33 for the debt/equity qualifiers. We asked the screener to tell iStock which companies have an ROA of 12.33 or higher – down to 343.
The average interest rate coverage is 500%, leaving 24 companies.
Unfortunately, our screener doesn't offer EDITDA history. For an alternative, we used enterprise value/EBITDA for the past 12 months, which leaves a dozen candidates. One other difference between our screening results versus those of the study. Perkins identified the qualifying companies on an industry by industry basis. For our purposes, we were sector agnostic.
According to the screen results, the 12 "highest quality", publicly traded companies are:
)Steven Madden, Ltd.
)Body Central Corp
)MSC Industrial Direct Co.
)Momenta Pharmaceuticals Inc
)Dorman Products, Inc.
)Qihoo 360 Technology Co. Ltd
)Mitcham Industries Inc
)SEI Investments Co
)Spirit Airlines, Inc.
)Dolby Laboratories, Inc.