Ned Davis Research has identified stocks like Apple (APPL), ExxonMobil (XOM) and Visa (V) as top long-term picks after assessing over 200 metrics spanning 40 years. Global Investment Solutions Head Brian Sanborn cautions against investors trying to "neglect the long-term drivers of stock returns," just because of recent volatility.
Sanborn tells Yahoo Finance that by analyzing five vital areas - cash flow multiples, operating cash efficiency, accrual ratios, earnings alignments and price momentum - NDR's model is able to tap enduring performance through varied conditions. Sanborn notes that diverse sectors are represented, from tech to energy, and that companies that did make the list have remained cash-flow generating, even through crises such as the COVID-19 pandemic.
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- As we near the end of the year, what should you be investing in for long term gains? Using things like free cash flow, price momentum, and shareholder yield, Ned Davis Research calculated the top stocks set up for long term returns with companies like Apple, Alphabet, and Exxon coming out on top. Brian Sanborn, Ned Davis Research Global Head Investment Solutions, joins us now. All right, so walk us through some of the findings here and why these particular companies really jumped out.
BRIAN SANBORN: All right. So as we were getting questions about next year, the election year uncertainty as well as how to position for a potential Fed rate cut or recession versus soft landing, we wanted to remind our clients not to neglect the long term drivers of stock returns. So we looked at 200 different metrics over the last 40 years, including macroeconomic sensitivities, fundamentals, technicals, and sentiment, and we looked at the return streams each of those characteristics over time.
And what we found was that there were five core drivers of stock returns. Free cash flow to enterprise value has been the most powerful driver of stock returns over the long term. It is a measure of valuation. Operating cash flow to assets is a measure of asset efficiency. Looking at accruals ratios. It's a measure of earnings quality. Looking at the difference between earnings and cash flows. Looking at a measure of payout, shareholder yield, which combines dividend yield, net debt reduction yield, and net repurchase yield. And lastly, looking at the price action, price momentum. In particular, we look at the one year rate of change in a stock's price and taking out the last month because the last month tends to be more reverting.
- So Brian, we mentioned the fact there in that intro, some of the favored stocks that include some of the larger well-known names like Apple, Alphabet, ExxonMobil. But what are some of the other additions that fall into the criteria that you just laid out that you're adding to your portfolio now?
BRIAN SANBORN: Right. And so in terms of the sector distribution here, there is quite a nice representation of different sectors from energy, materials, industrials, communication services, the tech sector, as well as consumer discretionary. In fact, consumer discretionary and information technology are the two most represented sectors in this particular list.
The types of names, as you mentioned, are some of those mega-cap names. Your Apples, Alphabets, ExxonMobil. But also names like TJX Company, Booking Holdings, Marathon Petroleum, as well as Parker-Hannifin also came out in this particular list.
- And so within this list, how much of it is kind of continuing to evaluate some of the economic inputs? I mean, we were just having a conversation about whether or not we're going to see a soft landing or whether that would translate into or potentially see a mild recession. How much of that kind of changes where these top companies are coming out?
BRIAN SANBORN: In terms of the characteristics themselves, and this analysis was done over the last 40 years, so it includes the global financial crisis, the COVID shutdown. And so these metrics have held up over during those periods of time. And so ultimately what the story is those companies that can efficiently generate cash flow, whose earnings reflect those cash flows, properly reward their equity shareholders through those cash flows, as well as the market recognizing that too while not being overvalued.
And so in these particular companies, they have consistently generated those cash flows over time. And so that's why they're appearing in this existing list. However, if we do go into recession, there are additional factors you can bolt on to these concepts, such as earnings stability, looking at the earnings volatility over time, as well as looking at metrics like dividend yield itself. Higher dividend yield companies tend to outperform during recessions.
- Brian, is that something that you're starting to do now given the fact that we have seen more and more strategists it seems like coming out, warning that we could or maybe it's time investors do start bracing for some sort of recession in the first half of the year?
BRIAN SANBORN: We're not there yet. So Ned Davis himself put out a publication on Friday evaluating the economic indicators. Right now, we're just not seeing enough to indicate that a recession is imminent. The economic data are slowing. But NDR's US recession probability model is currently showing less than 20% odds that a recession is imminent.