Among stocks that trade on the New York Stock Exchange and the Nasdaq, consumer cyclical companies generally have the highest Yacktman forward rate of returns. Since higher rates of return generally imply good investments, the consumer cyclical sector has increased growth opportunities compared to the consumer defensive and industrial sectors.
A note on the sectors and a brief introduction
A previous article discussed the top three sectors based on Altman Z-scores: consumer cyclical, consumer defensive and industrials. This article will focus on these three sectors and compare the distribution of the forward rate of return across the sectors. Since the Yacktman forward rate of return, like the Altman Z-score, can potentially range from negative infinity to positive infinity, this study will only consider the stocks whose rate of return is between -100% and 500%. Based on the analysis, here are the best sector to invest in.
Yacktman and his financial metric
Donald Yacktman (Trades, Portfolio), partner and portfolio manager of Yacktman Asset Management Co., had a strong executive history. As mentioned on his profile and performance page, Yacktman received the “Morningstar Portfolio of the Year” in 1991. After serving as senior portfolio manager of two mutual funds, Selected Financial Services Inc. and Selected American Shares, for about two decades, Yacktman founded Asset Management.
The president of Asset Management invests in companies with a strong history of “shareholder-oriented management.” Additionally, Yacktman invests only when the company trades at relatively cheap prices, i.e. most likely near 52-week lows.
Yacktman introduced the forward rate of return in his 2013 interview with GuruFocus: The rate of return, according to Yacktman, is the anticipated future return of an investment made at the current stock price. GuruFocus defines the forward rate of return as the company’s normalized free cash flow divided by its stock price, plus either the total revenue growth, per share revenue growth or 20%, whichever is lowest. Generally, companies with higher forward rates of return have higher potential for value and growth.
A brief discussion of the distribution of rates of return
For this study, a company is a good investment if its rate of return is at least 20% and higher than its median rate of return. Based on statistical analysis, the consumer cyclical sector likely has the highest number of good investments.
The consumer cyclical sector is likely the best sector based on the mean rate of return. However, since the mean only gives an initial outlook, investors should not rely on the mean to make investing decisions, as mentioned in an earlier article discussing about the strongest sectors based on Altman Z-scores. Although the consumer cyclical sector has the highest mean forward rate of return, it also has the highest standard deviation and range. Even though this suggests high volatility in expected returns, the consumer cyclical industry likely still has the highest growth potential among the three sectors.
All three distributions are roughly symmetric: consumer cyclical companies, consumer defensive companies and industrial companies have a mean forward rate of return of 11.26%, 7.20% and 7.91%, respectively. Additionally, the distribution of rates of return peaks around 20% for consumer cyclical and industrial companies.
Consumer cyclical companies have the highest growth potential
Further statistical analyses suggest that consumer cyclical companies have the highest growth potential based on Yacktman’s financial metric. Of consumer cyclical companies, 24.72% have a forward rate of return of at least 20%, while only 19.33% of industrial companies and 14.62% of consumer defensive companies have at least a 20% rate of return. Additionally, about half of the consumer cyclical companies currently have a rate of return greater than their median rate of return, implying an above-average anticipated return for an investment made at the current stock price.
Among consumer cyclical stocks, 22% are likely to be good investments. On the other hand, only 11% of consumer defensive stocks and 17% of industrial stocks have at least a 20% forward rate of return and greater than the median rate of return.
See also
In the previous article, we introduced the “Strong Stocks 2016” screener, which generated a list of 20 stocks. We can now add the following filter: the company has a forward rate of return of at least 20%. This filter reduces the stock list to just eight stocks. Among these stocks, Cal-Maine Foods Inc. (CALM, Financial) has the highest rate of return of 40.1%, implying high value and growth potential.
For more information about the sectors, you can view Sector Picks, which lists all guru trades within a sector. Additionally, the Industry Overview allows you to view which industries has the highest yields or the lowest valuations.
Disclosure: The consumer defensive industry had an outlier, with a forward rate of return of about 235%. Additionally, the author has no position in any stock mentioned in the article.
Start a free 7-day trial of Premium Membership to GuruFocus.
