Stocks With Low Risk/Reward Scores
AAII’s Charles Rotblut lays out a risk/reward scorecard in his upcoming book “Better Good Than Lucky” (W&A Publishing). The scorecard uses 10 basic tests of stock valuation, company performance and financial strength, and portfolio diversification to calculate a risk/reward score that tries to measure if a stock might be an attractive candidate for a portfolio. Eight of the measures are quantitative tests suitable for screening, while two of the measures are qualitative and require investor judgment. This issue’s First Cut uses AAII’s Stock Investor Pro to create a risk/reward score tied to the eight quantitative elements of the scorecard and presents 27 stocks with the lowest--that is, best--score.
The valuation elements of the score reward stocks with low price-to-book-value and price-earnings ratios. The company performance elements reward companies with consistently positive cash flow from operations and year-over-year increases in revenue, net income and earnings per share. Analysts’ perception of improving company fortunes is measured by examining changes in consensus estimates over the last month. Company financial strength is scored by looking at levels of the current ratio (current assets divided by current liabilities) and debt-to-equity ratio (long-term debt divided by equity and expressed as a percentage). Comparative performance is scored by measuring the return on equity (ROE, net income divided by equity) relative to all firms. For all of the elements, the most attractive figures are given a score of one, while least desirable figures are given a score of five. The scores are added together to form the risk/reward score. Only one stock had a best-possible score of eight, but 27 stocks had scores of 10 or lower. We did not score firms on their ability to maintain a competitive edge or how a stock might help diversify your portfolio holdings, which are also part of the risk/reward score.
...To continue reading this article you must be registered with AAII.
Already registered with AAII? Login to read the rest of this article.
to read this article and receive access to future AAII.com articles.