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Barron’s 400 Index Mid Year Update

Barron's 400 Newsletter. Powered by: MarketGrader.com

The Barron’s 400 Index closed another successful semester last week, largely recovering the ground lost to its benchmark, the Dow Jones U.S. Total Stock Market Index (DJUSTSM), in 2014. Through June 30th, B400’s total return of 5.83% was leading the benchmark’s 1.92% gain, a 391 basis point advantage. The comparison against the S&P 500’s total return was even better with a 460 basis point advantage on a year-to-date basis. Such leap ahead put B400 squarely on par with both DJUSTSM and the S&P 500 over the last 52-weeks, with B400’s one-year total return of 7.19% matching DJSTSM’s gain identically. S&P 500, on the other hand, was still barely ahead, up 7.42%. Long time followers of B400 will recognize this type of performance as typical behavior for the index, which, over longer periods of time, usually outperforms the benchmarks thanks to its GARP (Growth at a Reasonable Price) methodology, which systematically picks the most promising companies in the country at reasonable valuations. The table below illustrates the long-term advantage B400 has enjoyed since its launch on the cover of Barron’s on September 3, 2007.
 
Barron’s 400 Index Cumulative Return vs. Select Benchmarks (all values total returns)

IndexYTD (6/30/2015)1 Yr.3 Yrs.5 Yrs.Since Launch (9/3/2007)
Barron’s 4005.8%7.2%72.4%132.4%94.6%
Dow Jones US Total Stock Market1.97.262.8121.971.1
S&P 500 Index1.27.461.4120.265.9

Source: Bloomberg

Further evidence of this long-term advantage may be found in the index’s capture ratios, which we have also measured since its launch. An index’s capture ratio essentially measures its compound return relative to its benchmark’s return by comparing how much of the benchmark’s positive vs. negative returns it captures. The capture ratio is itself based on two distinct ratios: the up capture ratio and the down capture ratio. The first one measures the index’s compound return when the benchmark’s value increased and the second one measures its compound return when the benchmark’s value decreased. The ratio of up capture to down capture ratios is nicely summarized in the capture ratio. An up capture ratio above 100 means the index captured 100% of the benchmark’s upside for a given period and then some. If the number falls below 100%, it means it failed to keep pace with the benchmark. The same applies to down capture. A number above 100% means that, when the benchmark was down, the index captured the entire drawdown and then some. In an ideal world your index, or portfolio, would have an up capture above 100% and a down capture below 100%. Thus, an index that successfully outpaces its benchmark should have a capture ratio above one (1).
 
The table below illustrates the Barron’s 400 Index’s capture ratios vs. DJUSTSM as well as the S&P 500.
 
B400 Upside Capture and Downside Capture Ratios – through June 30, 2015

 
B400 TR vs.
3 Years 5 Years Since Launch*
Up Capture Down Capture Capture Ratio Up Capture Down Capture Capture Ratio Up Capture Down Capture Capture Ratio
DJUSTSM TR 115.27% 104.54% 1.10 131.93% 105.19% 1.25 169.18% 100.79% 1.68
                   
S&P 500 TR 112.00% 101.86% 1.10 128.21% 104.58% 1.23 173.55% 100.86% 1.72

 
In closing our summary for the year’s first semester, it is worthwhile taking a look at how B400 turned in such an impressive performance based on the individual performance of its underlying components. This also goes a long way toward showing the benefits of its bottom-up selection methodology and of its equal weighting.
 
In order to do so, we ran an attribution analysis using FactSet in order to separate the winners from the losers and to determine where the biggest contributions to performance came from, at least from on a component-by-component basis. In this particular analysis we did not focus on subsets of companies such as sectors or market cap segments, something we have done in the past and have presented in this column.
 
During the six months ended on June 30th, B400 held a total of 554 constituents, given that the period straddled two rebalance periods based on the March 23 reconstitution. Thus, 154 constituents were replaced in March. Today, only 550 of the 554 constituents remain in the index as a result of corporate actions. Of those, 325 companies gained in price over the last six months, while 225 lost, for a ratio of 1.44, which is not bad at all, especially considering that each company gets the opportunity to contribute equally to the index’s overall performance since all components are equally weighted. The results are summarized below:
 
Total companies held during the semester: 554
Total companies left after corporate events: 550
Total number of companies with price gains: 325
Total number of companies with price declines: 225
Average total return for all companies held: 3.99%
Average total return for all gainers: 14.12%
Average total return for all losers: -10.62%
Aggregate total return of all gainers: 11.65%
Aggregate total return of all losers: -5.73%
Average contribution to total index return by all gainers: 0.04%
Average contribution to total index return by all losers: -0.03%
 
What Lies Ahead?
 
As we have been arguing for some time, we believe future price gains in U.S. stock prices, in general and at least in the next year or so, will be largely dependent on earnings growth rates and not on multiple expansion, given where current valuations and profit margins stand. So, right on queue, our own John Prestbo has just written about the earnings seasons that Alcoa kicked off Wednesday evening from the perspective of B400 compared to the S&P 500. As you may see from John’s column below, the trend of consensus analysts estimates is almost as important as the upcoming results themselves; after all, the stock market is a discount mechanism that always looks forward. With that said, we’ll let our readers judge for themselves as to what set of companies stands to benefit the most from upcoming earnings reports.
 

B400 Companies Predicted to Post Solid 2Q Results

By John Prestbo – 07/08/2015

Companies in the Barron’s 400 Index are expected to post solid if not spectacular gains when they report their second-quarter earnings and revenue this month and next.
 
Security analysts’ estimates as of July 3 indicated the Barron’s 400 companies in aggregate would report per-share earnings 2.7% higher than actual profit in the year-earlier period on a 0.5% increase in revenue. By comparison, predictions for companies in the S&P 500 pointed to a 2.7% decline in per-share earnings year over year on a 5.2% drop in revenue.
 
As usual, analysts trimmed their expectations as the quarter’s end drew nigh. Six months ago, they were forecasting an 11% increase in per-share earnings for the Barron’s 400 companies and a nearly 8% gain for S&P 500 companies. But they trimmed deeper for the S&P 500 than for the Barron’s 400, as the chart below shows.


The lower expectations for S&P 500 companies are evident in almost every market sector. There was consensus on which sector fared the worst—energy—but the expected damage is greater for the S&P 500. By the way, oil prices started plunging at the end of last year’s second quarter, so from here on the year-to-year comparisons won’t be as onerous for energy companies.
 
Analysts predicted financials did the best in the Barron’s 400 while in the S&P 500 health care took the honors. Only in health care and materials did analysts look for better EPS results in the S&P 500 than in the Barron’s 400. As for forecasted revenue gains, Barron’s 400 companies had the edge in every sector except telecommunications. Details of the comparisons between estimates and year-earlier actual results are shown in the following table:
 

Median Pct. Chg. of 2Q 2015 Estimate vs. 2Q 2014 Actual
  Barron’s 400 S&P 500
  EPS Revenue EPS Revenue
Consumer Discretionary 6.0% 6.5% 1.8% 2.5%
Consumer Staples 6.0% 4.0% 1.2% 0.2%
Energy -64.7% -18.5% -71.6% -34.4%
Financials 8.2% 1.7% 4.6% -0.5%
Health Care 7.2% 6.6% 8.3% 4.8%
Industrials 4.3% 5.6% 4.2% -2.9%
Materials -2.4% 4.7% 2.3% -4.6%
Technology 9.7% 5.4% 2.5% -0.8%
Telecommunications 2.4% -1.8% -15.7% 3.3%
Utilities 5.3% 5.8% 0.8% 0.6%

Stock size is another way to slice the market. The S&P 500 is weighted by market capitalization, so the different behaviors of size segments have a direct bearing on index performance. The Barron’s 400, which is equally weighted but encompasses more size categories, also is affected by which sizes are in favor and which are out. How second-quarter expectations varied by stock size is shown in this table:

Median Pct. Chg. of 2Q 2015 Estimate vs. 2Q 2014 Actual
 Barron’s 400S&P 500
 EPSRevenueEPSRevenue
Mega Cap (>$10 billion)6.0%2.5%4.0%0.9%
Large Cap ($3 bln-$10 bln)8.4%5.6%-2.0%-1.4%
Mid Cap ($1 bln-$3 bln)4.0%6.8%
Small Cap ($500m-$1 bln)-5.7%2.3%
Micro Cap (< $500 mln)-28.7%-10.2%

 
In general, the bigger the stocks the more positive the expectations. Question is, can these stocks attract enough additional investment dollars to boost their prices even higher? Lots of factors influence the answer, and among them will be the actual earnings and revenue results these and other companies will post in the weeks ahead. For now, the Barron’s 400 companies have the better prognosis.

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