The Terrible Ten

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“The Magnificent Seven” was the most popular sobriquet among stock market strategists, portfolio managers and reporters in 2023. Stocks such as Google, Nvidia, Tesla, Amazon, Microsoft, Meta, Apple dominated performance and volume charts. Almost unnoticed, Broadcom pushed its way to 4th in Market Cap in the Nasdaq and more than doubled in price last year but is still left out of the popular lists. Perhaps they should be called the “Elite Eight.”

That said, most of the aforementioned group of quotable experts expect some mean reversion for the top stocks in the S&P 500 and counsel avoiding market cap weighting in favor of equal weighting. There has been an Invesco ETF based upon an equal-weighted version of the S&P 500 for more than 20 years with the ticker symbol RSP. With such a top-heavy S&P, several experts have opined that investors may wish to switch to the equal-weighted S&P to mitigate the risk of a tech bubble.  

Decreasing a 45% weighting to the top 10 stocks in the S&P 500 Index to a 2% aggregate weight does decrease exposure to a tech bubble. At the same time, however, it increases exposure to other stocks in the index that have exposures to other industries and other economic factors. Since all 500 stocks comprise 0.2% of an equally weighted portfolio, any selection of 10 stocks comprises the same 2%. Equalizing exposure for tech leaders to other stocks – if they can be found – with similar ratios of expected return to expected risk level sounds to us like an attractive strategy. However, all 500 stocks in the index at a given time may not have similarly attractive profiles. So, for those who prefer an equally weighted portfolio, what S&P 500 companies might you want to examine more closely before allocating equivalent capital to their stocks as you do to the stocks in the S&P 500?

I ran that exercise in this week’s ValuEngine Screen. The objective was to find out how many stocks in the S&P 500 earned our lowest rank of (Strong Sell) for year-ahead performance according to our predictive model and also were in the most overvalued 25% of the ValuEngine universe according to our valuation model. The answer was 10. In contrast to “The Magnificent Seven.” I dubbed the stocks in this exercise in bottom fishing as “The Terrible Ten.” If you buy RSP, these 10 stocks account for the identical 2% of your portfolio as the top ten.

Here is a brief synopsis of the relevant companies:

  1. Steel Dynamics (STLD– Steel Dynamics, Inc., together with its subsidiaries, operates as a steel producer and metal recycler in the United States. It operates through three segments: Steel Operations, Metals Recycling Operations, and Steel Fabrication Operations. The Steel Operations segment offers hot rolled, cold rolled, and coated steel products; parallel flange beams and channel sections, flat bars, large unequal leg angles, and reinforcing bars, as well as standard strength carbon, intermediate alloy hardness, and premium grade rail products; engineered special-bar-quality products, merchant-bar-quality products, and other engineered round steel bars; channels, angles, flats, merchant rounds, and reinforcing steel bars; and specialty shapes and light structural steel products. Steel Dynamics, Inc. was founded in 1993 and is headquartered in Fort Wayne, Indiana.
  2. Nucor Inc. (NUE) – Nucor Corporation engages in the manufacture and sale of steel and steel products. The company’s Steel Mills segment produces hot-rolled, cold-rolled, and galvanized sheet steel products; plate steel products; wide-flange beams, beam blanks, and H-piling and sheet piling products; and bar steel products, such as blooms, billets, concrete reinforcing and merchant bars, and engineered special bar quality products. The company’s Raw Materials segment produces direct reduced iron (DRI); brokers ferrous and nonferrous metals, pig iron, hot briquetted iron, and DRI; supplies ferro-alloys; and processes ferrous and nonferrous scrap metal. The company was founded in 1905 and is headquartered in Charlotte, North Carolina.
  3. CF Industries (CF) – CF Industries Holdings, Inc. manufactures and sells hydrogen and nitrogen products for energy, fertilizer, emissions abatement, and other industrial activities worldwide. Its principal products include anhydrous ammonia, granular urea, urea ammonium nitrate, and ammonium nitrate products. The company also offers diesel exhaust fluid, urea liquor, nitric acid, and aqua ammonia products; and compound fertilizer products with nitrogen, phosphorus, and potassium. It primarily serves cooperatives, independent fertilizer distributors, traders, wholesalers, and industrial users. The company was founded in 1946 and is headquartered in Deerfield, Illinois.
  4. Valero Energy (VLO) – Valero Energy Corporation manufactures, markets, and sells transportation fuels and petrochemical products in the United States, Canada, the United Kingdom, Ireland, Latin America, and internationally. It operates through three segments: Refining, Renewable Diesel, and Ethanol. It sells its refined products through wholesale rack and bulk markets; and through outlets under the Valero, Beacon, Diamond Shamrock, Shamrock, Ultramar, and Texaco brands. The company also produces and sells ethanol, dry distiller grains, syrup, and inedible corn oil primarily to animal feed customers.  Valero Energy Corporation was founded in 1980 and is headquartered in San Antonio, Texas.
  5. Skyworks Solutions (SWKS) – Skyworks Solutions, Inc., together with its subsidiaries, designs, develops, manufactures, and markets proprietary semiconductor products in the United States, China, South Korea, Taiwan, Europe, the Middle East, Africa, and the rest of Asia-Pacific. Its product portfolio includes amplifiers, antenna tuners, attenuators, automotive tuners and digital radios, DC/DC converters, demodulators, detectors, diodes, wireless analog system on chip products, directional couplers, diversity receive modules, filters, front-end modules, hybrids, light emitting diode drivers, low noise amplifiers, mixers, modulators, opto-couplers/opto-isolators, phase locked loops, phase shifters, power dividers/combiners, power over ethernet, power isolators, receivers, switches, synthesizers, timing devices, voltage controlled oscillators/synthesizers, and voltage regulators  The company was founded in 1962 and is based in Irvine, California..
  6. Microchip Technology (MCHP) – Microchip Technology Incorporated develops, manufactures, and sells smart, connected, and secure embedded control solutions in the Americas, Europe, and Asia. The company offers general purpose 8-bit, 16-bit, and 32-bit microcontrollers; 32-bit embedded mixed-signal microprocessors; and specialized microcontrollers for automotive, industrial, computing, communications, lighting, power supplies, motor control, human machine interface, security, wired connectivity, and wireless connectivity applications. The firm was incorporated in 1989 and is based in Chandler, AZ.
  7. Marathon Petroleum (MPC) – Marathon Petroleum Corporation, together with its subsidiaries, operates as an integrated downstream energy company primarily in the United States. It operates in two segments, Refining & Marketing, and Midstream. The Refining & Marketing segment refines crude oil and other feedstocks at its refineries.  It also purchases refined products and ethanol for resale and distributes refined products, including renewable diesel. Its refined products include transportation fuels, such as reformulated gasolines and blend-grade gasolines; heavy fuel oil; and asphalt. The company was founded in 1887 and is headquartered in Findlay, Ohio.
  8. Viatris, Inc. (VTRS) – Viatris Inc. operates as a healthcare company worldwide. The company operates in four segments: Developed Markets, Greater China, JANZ, and Emerging Markets. It offers prescription brand drugs, generic drugs, complex generic drugs, biosimilars, and active pharmaceutical ingredients (APIs). The company offers drugs in various therapeutic areas, including non communicable and infectious diseases; biosimilars in the areas of oncology, immunology, endocrinology, ophthalmology, and dermatology; and APIs for antibacterial, central nervous system agents, antihistamines/anti-asthmatics, cardiovascular, antivirals, antidiabetics, antifungals, and proton pump inhibitor areas, as well as support services, such as diagnostic clinics, educational seminars, and digital tools to help patients better manage their health. The company was founded in 1961 and is headquartered in Canonsburg, Pennsylvania. 
  9. KeyCorp Inc. (KEY) – KeyCorp operates as the holding company for KeyBank National Association that provides various retail and commercial banking products and services in the United States. It operates in two segments, Consumer Bank and Commercial Bank. The company offers various deposits, investment products and services including personal finance and financial wellness, student loan refinancing, mortgage and home equity, lending, credit card, treasury, business advisory, wealth management, asset management, investment, cash management, portfolio management, and trust and related services to individuals and small and medium-sized businesses.  The company was founded in 1849 and is headquartered in Cleveland, Ohio.
  10. International Paper (IP) – International Paper Company produces renewable fiber-based packaging and pulp products in North America, Latin America, Europe, and North Africa. It operates through the Industrial Packaging and Global Cellulose Fibers segment. The company’s Industrial Packaging segment manufactures containerboards, including linerboard, medium, whitetop, recycled linerboard, recycled medium, and saturating kraft. Its Global Cellulose Fibers segment provides fluff, market, and specialty pulps that are used in absorbent hygiene products, such as baby diapers, feminine care, adult incontinence, and other non-woven products; tissue and paper products; and non-absorbent end applications, including textiles, filtration, construction material, paints and coatings applications. In addition, it sells its products directly to end users and converters, as well as through agents, resellers, and distributors. The company was founded in 1898 and is headquartered in Memphis, Tennessee.

The following two tables compare the 10 companies on fundamental ratios and historical price-related factors. ValuEngine’s proprietary measures, Rating, Fair Value and Forecast 1-Yr. Returns are also included. Universe percentile ranks with 99 being the best and 1 being the worst are also included.  The Fair Value measure applies our valuation model to the current price to determine the “fair value” price of the stock.  

Ticker STLD NUE CF VLO SWKS
Name STEEL DYNAMICS NUCOR CORP CF INDUS HLDGS VALERO ENERGY SKYWORKS SOLUTN
Sector Basic Materials Basic Materials Basic Materials Oils-Energy Computer and Technology
Industry Steel

 

producers

Steel

 

producers

Fertilizers OIL Refining & Marketing Semi-radio Freq
Market Price 124.99 186.54 78.08 143.06 105.05
Avg Volume 1316966 1525253 2048794 3269254 1938604
Rating 1 1 1 1 1
Fair Value 67.32 97.05 58.13 106.42 76.47
Valuation(%) 85.66 92.21 34.31 34.43 37.38
Valuation Rank 5 5 21 21 19
Forecast 1-Mon Price Change (%) -1.65 -1.45 -1.37 -1.27 -1.23
1-Mon Forecast Rank 1 2 2 2 3
Forecast 1-Yr Price Change (%) -19.52 -17.24 -16.32 -15.11 -14.69
1-Yr Forecast Rank 1 2 2 2 3
Last 12-Mon Price Change (%) 3.00 14.03 -10.05 7.87 -13.09
Momentum Rank 58 75 36 67 33
Sharpe Ratio 0.58 0.50 0.28 0.19 0.20
Sharpe Ratio Rank 91 89 79 74 74
5-Yr Avg Price Change (%) 23.87 22.32 10.96 9.17 7.16
5-Yr Price Change Rank 95 95 85 82 78
Volatility(%) 40.93 44.35 38.74 47.70 35.67
Volatility Rank 44 41 46 38 50
EPS Growth(%) -28.61 -33.12 -22.61 -32.36 -11.82
EPS Growth Rank 7 6 8 6 14
Avg EPS Suprise(%) 0.01 0.10 0.07 0.11 0.04
Suprise Rank 38 63 56 63 48
Market Cap 20.2 45.9 14.9 48.7 16.8
Size Rank 91 96 89 96 90
Dividend Yield (%) 1.4% 1.2% 2.6% 3.0% 2.6%
P/E Ratio 8.5 10.6 10.3 6.2 15.5
P/E Rank 87 81 82 94 67
M/B Ratio 2.5 3.2 2.4 1.7 6.3
M/B Rank 41 35 43 53 21
P/S Ratio 1.1 1.3 1.9 0.3 3.5
P/S Rank 66 61 47 88 31
Actual EPS 14.62 17.64 7.57 22.93 6.80
Forecast EPS 10.44 11.80 5.86 15.51 5.99
Beta 1.40 1.61 1.04 1.52 1.41

 

Ticker MCHP MPC VTRS KEY IP
Name MICROCHIP TECH MARATHON PETROL VIATRIS INC KEYCORP NEW INTL PAPER
Sector Computer and Technology Oils-Energy Medical Finance Basic Materials
Industry Semi-analog & Mixed OIL Refining & Marketing Medical Services Banks-major Regional Paper & Paper Products
Market Price 85.44 169.97 11.68 13.89 35.26
Avg Volume 5107286 3065611 8935946 1685063 3379160
Rating 1 1 1 1 1
Fair Value 62.60 115.21 8.71 10.15 25.60
Valuation(%) 36.49 47.53 34.17 36.86 37.75
Valuation Rank 19 13 21 19 18
Forecast 1-Mon Price Change (%) -1.12 -1.12 -0.99 -1.15 -1.01
1-Mon Forecast Rank 3 3 5 3 4
Forecast 1-Yr Price Change (%) -13.41 -13.38 -11.94 -13.76 -12.10
1-Yr Forecast Rank 3 3 5 3 4
Last 12-Mon Price Change (%) 0.65 40.77 -0.34 -28.95 -8.11
Momentum Rank 54 90 50 19 38
Sharpe Ratio 0.38 0.36 -0.46 -0.06 -0.19
Sharpe Ratio Rank 84 83 20 44 34
5-Yr Avg Price Change (%) 15.03 18.32 -18.68 -2.51 -5.61
5-Yr Price Change  Rank 90 93 24 42 36
Volatility(%) 39.57 50.70 40.54 42.50 29.76
Volatility Rank 46 36 45 43 57
EPS Growth(%) -49.41 -29.22 -5.23 5.08 -6.73
EPS Growth Rank 4 7 19 32 18
Avg EPS Surprise (%) 0.01 0.24 0.06 0.05 0.19
Suprise Rank 38 78 53 51 74
Market Cap 46.2 64.5 14.0 13.0 12.2
Size Rank 96 97 89 88 87
Dividend Yield (%) 2.0% 1.9% 4.2% 5.9% 5.3%
P/E Ratio 16.0 7.7 3.9 11.8 17.0
P/E Rank 66 90 98 77 64
M/B Ratio 6.6 2.7 0.7 1.1 2.1
M/B Rank 20 39 84 70 47
P/S Ratio 5.2 0.4 0.9 1.3 0.6
P/S Rank 23 85 70 62 78
Actual EPS 5.33 22.12 2.97 1.18 2.08
Forecast EPS 2.70 15.65 2.81 1.24 1.94
Beta 1.66 1.64 1.19 1.35 1.00


OBSERVATIONS

  1. ValuEngine’s predictive metrics on all 10 stocks are for substantial declines. They are all rated (Strong Sell) by our time tested predictive model. The range of losses projected for the next 12 months spans from 11.9% to 19.5%.  All ten of these stocks are rated between 34% and 92% overvalued by our valuation model with the result that each one has a current price substantially higher than its Fair Value price. All of the companies associated with these stocks have negative earnings growth with regional bank KeyCorp (KEY) being the sole exception. The same 9 of 10 also have further declines in EPS predicted for 2024.  8 of 10 are in the top half of price volatility. Given our models’ sour assessments, it might be surprising that all of them have attractive absolute Price/Earnings Ratios ranging from a low of 3.9 to a high of 17, all much lower than the P/E ratios of the cap-weighted S&P 500 and the Nasdaq-100. This can be principally attributed to the fact that P/E is backwards looking whereas the valuation model is built to be more forward looking, considering price-to-earnings-growth (PEG ratio) as more important among the many factors it considers.
  2. Equal-weighted RSP has more evenly distributed sector weights than SPLG (or the more expensive SPY or other cap-weighted S&P 500 ETFs). This group illustrates why as only 2 of the 10 stocks are in the computer and technology sector. 4 of the 10 are in Basic Materials (Steel, Fertilizers and Paper). 2 of the 10 are in Oil/Energy. One apiece are in Banks and Medical Services.
  3. The two tech companies, Skyworks (SWKS) and Microchip Technologies (MCHP) both performed very poorly during the past 12 months compared with XLK, the Select Sector SPDR Technology Index ETF. The latter has returned more than 30% during the past 12 months.
  4. Other than Steel Dynamics (STLD) which started in 1993 and Microchip which started in 1989, these companies have been around from between 61 years and 173 years. From a corporate life cycle perspective, many of these may be well in the late part of the maturity phase and/or already in the early parts of the decline phase.  Note that one of the jobs of the Standard & Poor’s Index Committee is to identify and eliminate stocks well into the decline stage. I believe that it is safe to say at this time that stocks such as Nucor (NUE), CF Industries (CF) and Keycorp (KEY) are currently bought more by index funds than investors specifically looking to take or increase stakes in these companies. Therefore when the day comes that they are dropped from the S&P 500, their prices will be susceptible to more precipitous declines. 
  5. The major positive for many holders of these stocks is dividend yield. All except for NUE and STLD have considerably higher yields than the S & P 500. The highest yields belong to KEY and International Paper (IP), both more than 5%. In general, “old economy” materials, energy and utility stocks will yield more than tech stocks and early stage stocks. Generous dividend yields are purposeful incentives for income-oriented investors to buy and hold these stocks. Do not expect such stocks to keep pace in a bull market However, they may not decline as much or at all while providing income in a bear market.

SUMMARY

The sobriquet “Magnificent Seven” for market leadership stocks linked to technologies with seemingly unlimited upside does not guarantee that these stocks will still be producing handsome investment returns in the next 12 months. Similarly, my dubbing these 1-rated S&P 500 stocks “Terrible Ten” does not mean that they will fulfill our models’ prognostications and underperform during the same period.  

Since investors read many more articles about stocks to consider buying than stocks to avoid or consider selling, I thought it was useful to highlight some potential negative aspects of equally weighting an S&P 500 indexed portfolio. After all, SPLG (SPDR S&P 500 Index ETF) outperformed RSP by nearly 1300 basis points (or +12.95%) in calendar year 2023. We project higher price gains again in 2024 for SPLG than for RSP.  No one knows whether all this analysis will be right or wrong until after the fact. The point of this article is to keep readers informed of what the signals mean and what the potential tradeoffs are.


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