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    IBD Stable 70: Surviving Downturns With Long-Term Earnings Growth

    by Wayne A. Thorp

    IBD Stable 70: Surviving Downturns With Long Term Earnings Growth Splash image

    Two years ago, the analysts and editors at Investor’s Business Daily attempted to identify the characteristics of those companies that had weathered the recent economic and stock market downturn. The goal was to apply those factors going forward to identify “recession-proof” companies. The fruit of their efforts was the Stable 70 list, which consists of companies with strong and stable long-term earnings growth.

    Using AAII’s Stock Investor Pro fundamental stock screening and database program, we recreated the IBD Stable 70 screen. The screening criteria, based upon our interpretation, are:

    • Earnings per share from continuing operations for the trailing 12 months is equal to or greater than earnings per share from continuing operations for the last fiscal year;

    • Earnings per share from continuing operations has increased by at least 10% over each of the last five fiscal years;

    • Quarter-on-quarter earnings and sales growth is at least 10%, as defined by growth between the latest fiscal quarter and the same quarter one year prior;

    • The trend in growth in earnings per share from continuing operations is reasonably stable over the last seven years;

    • The latest price per share is at least $12;

    • The stock must be exchange listed; and

    • The company is not an ADR/ADS stock—a foreign company listed on a U.S. exchange.

    TABLE 1. Current Portfolio Characteristics
      IBD
    Stable 70
    Screen
    Exchange-
    Listed
    Stocks
    Price-earnings ratio 26.3 19.1
    EPS growth rate (qtr on qtr) 26.70% 12.50%
    Historical EPS growth rate (5 yr) 30.90% 3.00%
    Estimated EPS growth rate (3-5 yr) 18.30% 14.00%
    Sales growth rate (qtr on qtr) 17.20% 4.60%
    Historical sales growth rate (5 yr) 22.30% 8.70%
    Market cap (million) $2,755.30 $281.10
    Price as % of 52-wk high 94.00% 92.00%
    Relative strength vs. S&P 500 27.00% 11.00%
    Monthly Observations
    Average no. of passing stocks 60  
    Highest no. of passing stocks 103
    Lowest no. of passing stocks 24
    Monthly turnover 11%

    The Stable 70 Group

    Figure 1.
    Performance vs.
    Benchmarks
    CLICK ON IMAGE TO
    SEE FULL SIZE.

    Backtesting the IBD Stable 70 screen on a monthly basis over the last five and a half years revealed that the IBD Stable 70 screen has been able to easily outperform the small-, mid-, and large-cap indexes over this time period. Figure 1 shows its five-year performance.

    The characteristics of the of the stocks passing the IBD Stable 70 screen are presented in Table 1, while Table 2 lists the current roster of passing companies. The screen is a pure growth screen, so perhaps it is not surprising that the portfolio’s price-earnings ratio (share price divided by earnings per share) of 26.3 is above the median figure of 19.1 for all exchange-listed stocks.

    FIGURE 1. Screen Performance
      Return (%)
    Cum'l Best
    Month
    Worst
    Month
    YTD
    '03
    '02 '01 '00 '99 '98
    IBD Stable 70* 100.9 12 -18.9 31.9 -11.0 9.5 23.9 3.6 21.9
    S&P 500 12.6 9.8 -14.5 15.9 -22.1 -11.9 -9.1 21 28.6
    S&P MidCap 400 66 12.1 -18.6 21.7 -14.5 -0.6 17.5 14.7 19.1
    S&P SmallCap 600 40.5 13.4 -19.3 24.6 -14.6 6.5 11.8 12.4 -1.3
    All Exchange-Listed Stocks 94.8 23.9 -20.2 50.9 -13.3 21.2 -14.2 35.1 5.9

    In looking at several different growth rates, the companies passing the IBD Stable 70 screen surpass the median for all stocks. Most striking are the long-term growth rates in earnings and sales. The median historical earnings growth rate for the IBD Stable 70 companies is 30.9% compared to 3.0% for all companies, while the historical sales growth rate for the companies passing the screen is 22.3% versus 8.7% for all companies. Looking forward, the consensus estimated earnings growth rate over the next three to five years is slightly higher for the stocks passing the IBD Stable 70 screen.

    The median market capitalization (share price times number of shares outstanding) for the stocks passing the IBD Stable 70 screen is $2.76 billion, placing these stocks well into the mid-cap range.

    The companies that passed the IBD Stable 70 screen have been strong performers in terms of earnings growth as well as price performance, as represented by relative strength versus the S&P 500 index. The companies passing the IBD Stable 70 screen outperformed the S&P 500 by 27.0%, whereas exchange-traded stocks have outperformed the index by only 11.0%.

    Stocks Passing the Screen

    Thirty-one stocks currently pass the screen, well below the average of 60 that have passed over the last five and a half years. Table 2 ranks the current passing stocks by their price as a percent of their 52-week high.

    Investor’s Business Daily does not explicitly state which earnings figure it uses for its Stable 70 screen. This screen makes use of earnings from continuing operations, which ignores extraordinary and “one-time” charges and provides a better indication of a company’s earnings potential going forward.

    The original IBD Stable 70 screen makes use of an earnings stability rate, which shows how a company’s annual earnings compare with the trend of its earnings over the last five years. It is basically the standard deviation of earnings. Building this IBD Stable 70 screen with Stock Investor Pro, R-squared for earnings per share from continuing operations over the last seven years is used as a proxy for the filter. In simple terms, the R-squared measures how closely actual data falls to a trendline that is plotted using linear regression. A higher value for R-squared indicates a higher degree of stability or predictability for the plotted points.

    In the long run, earnings growth is driven by a corresponding increase in sales. A dip in sales may also be an early warning for deeper trouble down the line.

    The vast majority of passing companies are within striking-distance of their 52-week high, as shown by their price as a percent of 52-week high values. Cheesecake Factory, an operator of over 60 casual dining restaurants throughout the country, heads up the list at 99.1%. It has a long-term earnings growth rate of 30.9%, which is even with the median of the entire group. Its historical sales growth rate slightly exceeds that of the group at 25.6% over the last five years. From an earnings stability standpoint, the company has an R-squared for earnings growth of 98.0%, among the highest of those companies passing the IBD Stable 70 screen.

    At the other end of the price performance spectrum is Hilb, Rogal & Hamilton, with a price as percent of 52-week high of 65.0%. But it has managed to grow historical earnings at a rate—33.7%—higher than that of the overall group, and at 21.9% its sales growth rate is in line with that of the group of passing companies. Lastly, the company has an R-squared of earnings of 93.9%, demonstrating significant earnings stability over the last seven years.

    Conclusion

    The IBD Stable 70 screen looks for companies that are equipped to withstand economic and stock market downturns by isolating companies that have had strong long-term growth in earnings. Furthermore, the screen isolates companies that have been able to grow earnings in a stable manner.

    However, the companies that pass this or any other stock screen do not represent a recommended list. Stock screening is merely the first step: It is important to perform additional due diligence to identify stocks that may be investment candidates.


    Wayne A. Thorp, CFA, is financial analyst at AAII and associate editor of Computerized Investing.


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