Rules of the Game: Rock-Solid Bottom Lines

 | Feb 17, 2013 | 3:30 PM EST  | Comments
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Vanguard recently issued a study showing that fundamental metrics, such as earnings and gross domestic product, don't necessarily affect broad market moves. According to the data, the indices can see an outsized effect from some factors not regularly measured by analysts. For example, erratic GDP growth rates in recent quarters haven't done much to cripple S&P 500 appreciation.

Of course, the Fed's quantitative-easing campaign has made money readily available for institutional stock investing, and that has contributed to price growth.

I've become a proponent of more or less plain-vanilla ETFs as a way of capitalizing on asset-class strength. But the fundamentals still carry a great deal of weight for investors who want a portfolio of large- and mid-cap individual stocks to potentially add some alpha to their investment strategy. As I've noted here in previous weeks, I've been gravitating toward a longer-term philosophy, and away from the swing-trading methodology I've used for years. Along with that, I'm spending more time tracking large- and mid-cap stocks, and much less in the small-cap universe.

Don't misunderstand -- I am not against small-caps in any way. As I've stated for years, they can offer robust price appreciation, particularly in upward-trending markets. But in weaker market conditions, of course, they can lose more value than their larger brethren. So, rather than attempting to time the market and trade in and out of these names, I've taken to using small-cap ETFs to get exposure to this asset class.

Otherwise, when it comes to individual stock selection you can mitigate some of your risk by focusing on large-caps, adding a smattering of high-quality mid-caps to juice up alpha.

One screening criterion I often turn to is stability of earnings performance. Sure, you can't pinpoint future earnings based on past track record, but the ability to consistently deliver profitability does suggest that the firm has competent management. In addition, some data shows that companies with a solid history of delivering earnings growth will continue along that path.

When I ran that screen on Sunday, I noticed that foreign banks were well-represented. I've written about overseas-based financials previously, as that subsector continues to show good fundamental leadership.

Japan's Sumitomo Mitsui Financial Group (SMFG) is an example. It's important to note that this scan does not uncover companies with accelerating earnings growth, but those with a better-than-average recent history. In the past eight quarters, the company has been consistently profitable, although year-over-year earnings growth slipped in a couple of those periods.

Despite having market capitalization greater than $55 billion, Sumitomo only trades about 1.1 million shares per day. A glance at the weekly chart shows some intraweek volatility, something potential investors need to take into account.

India's HDFC Bank (HDB) also ranked highly on my scan for earnings stability. In this case, year-over-year earnings growth has been consistent every quarter for the past two years. Analysts see the company growing earnings by 20% and 28% in 2013 and 2014, respectively.

On the chart, the stock is consolidating below its November all-time high of $43.02. It closed Friday at $39.84, 10.4% above its 200-day moving average, and 1.7% below its 50-day.

As you often see with stocks that trade on American depositary receipts, this is a large-cap company with a comparatively light trading volume. HDFC moves about 788,000 shares per day despite having a market cap of nearly $31 billion. The stock has a higher beta, 1.24, than many large caps, and the relatively light volume may be a contributing factor.

One caveat: Although I've given two examples here of overseas banks with solid earnings histories, don't load up an individual stock portfolio with these or stocks from any closely related industry or subsector. That could potentially expose you to extra downside risk if some industry development takes down a big chunk of the sector.

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