Among companies trading on the New York Stock Exchange and the Nasdaq, consumer cyclical, consumer defensive and industrial companies generally have strong Altman Z-scores. This suggests that these sectors have the best potential for growth in the short term.
A note on the sectors
As implied on the Sector Picks page, there are currently 11 different industry sectors. While some of these sectors overlap, the sectors allow deeper analyses about the distribution of Z-scores. For example, such analyses can determine the best sectors to invest in based on financial strength metrics.
The sectors with the highest financial strength metrics provides a good guide to find the growth opportunities.
Higher mean Z-scores offer a good start
As a rough guide, the sectors that have a high mean Altman Z-scores present a good indicator that growth opportunities exist in that sector. With a mean Altman Z-score of 5.14, the health care industry likely has the most companies with strong Z-scores. On the other hand, REITs and utilities have the two lowest mean Altman Z-scores, suggesting that the majority of such companies are in distress.
One cannot just rely on mean Z-scores
The mean Altman Z-score can only give an initial snapshot of the overall strength of an industry sector. In other words, investors cannot rely just on mean Z-scores to make investing decisions. Other statistical measures, like the standard deviation, provide important information as well.
Although it has the highest mean Z-score, the health care industry also has the most volatile Z-scores, with a standard deviation of 6.37. Additionally, the range of the Z-scores for medical companies is 33.15, the second highest among all sectors. On the other hand, even though utilities companies have the lowest mean Z-scores, these companies have the lowest standard deviation. With the lowest range of 8.81, utilities companies have predictable, albeit low, Z-scores.
Generally, sectors with high mean Z-scores and a low standard deviations offer high growth opportunities. We can define a sector’s “rank score” by taking the sum of the ranks for a sector’s mean and standard deviation. The lower the rank score, the higher potential for growth opportunities in that sector. With the fourth highest mean Z-score and the third lowest standard deviation, the consumer cyclical sector has the lowest rank score. On the other hand, the energy sector has the highest rank score, implying the least potential for growth.
What makes a good investment?
While the main focus has been the current Altman Z-score of companies, two historical metrics can also determine whether the company is a good investment. As mentioned in an earlier article, the minimum Altman Z-score determines whether a company ever went into distress during its history. The higher the minimum Z-score, the less likely a company experienced distress historically and thus the stronger its business operation. Furthermore, if a company’s Piotroski F-score is currently above its median F-score, the company’s business operation likely strengthened throughout recent years. Such companies provide the highest growth potential.
Generally, if a company has a minimum Z-score less than 1.81, the company experienced financial distress historically. Additionally, companies whose current F-score is lower than its median F-score likely had weakening business operations. Therefore, the “good invest” random variable returns a 1 if the company never experienced distress during its history and has an above-average (current > median) Piotroski F-score. The top three sectors based on number of good investments are consumer defensive, consumer cyclical and industrials.
The best sectors to invest in are…
To determine the best sectors to invest in, we introduce the “investing score” by adding the good invest rank to the rank score defined earlier. The sectors with the lowest investing scores are likely the best sectors to invest in. Based on our findings, the top three sectors to invest in are consumer cyclical, consumer defensive and industrials.
To take this study further, we can generate a list of the strongest stocks using the All-in-One Guru Screener. A sample “Strong Stocks” screener contains the following filters:
- The stock trades in the U.S., and all over the counter stocks are excluded.
- The industry is either consumer defensive, consumer cyclical or industrials.
- The company’s financial strength rating is at least 7.
- The company’s profitability rank is at least 8.
- The company has at least an Altman Z-score of 5.
- The company has at least a Piotroski F-score of 7.
As of July 21, the above 20 stocks meet the above criteria, and thus they are likely the strongest stock buys.
See also
You can view all the guru trades within a certain sector using Sector Picks. Once you click on a sector name from the list, the resulting screen will detail all the buys that occurred in that sector during the past six months. You can also view the sells that occur by either clicking the “Here for sells” link next to the green “Buys in (sector name)” or choose “All Sells” from the “Buy/Sell” dropdown box.
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