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To find the top stocks to rally with a vaccine I have used the following hypothesis:
We should look for companies which before the pandemic were not in a decline. After all, even after the pandemic they would still fall.
They should be companies which rose in the year before the market peaked ie upto 21st February 2020, because that’s when the lockdown began (UK) and stocks fell for 4 weeks.
They should be companies which fell during the month 21st February to 21st March 2020. That is they were impacted.
They over the past 6 months have not recovered. Again, if they had, then there is no gain to be had.
They should be otherwise healthy companies. We do not want ones on the brink of bankruptcy, since the vaccine implementation may seen them collapse. So for these companies I would look for ones with high Altman scores and good CROCI scores.
Of course we want ones which have started rising now after the vaccine has been announced.
Introducing Altman Scores for Stocks
As this source says:
The Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.
The Z-score is a linear combination of four or five common business ratios, weighted by coefficients. The coefficients were estimated by identifying a set of firms which had declared bankruptcy and then collecting a matched sample of firms which had survived, with matching by industry and approximate size (assets).
Altman applied the statistical method of discriminant analysis to a dataset of publicly held manufacturers. The estimation was originally based on data from publicly held manufacturers, but has since been re-estimated based on other datasets for private manufacturing, non-manufacturing and service companies.
The original data sample consisted of 66 firms, half of which had filed for bankruptcy under Chapter 7.
Introducing CROCI
This is a measure of cash flow. This source puts it like this:
Cash return on capital invested[1] (CROCI) is an advanced measure of corporate profitability, originally developed by Deutsche Bank‘s equity research department in 1996 (it now sits within DWS Group).This measure compares a post-tax, pre-interest cash flow to the gross level of capital invested and is a useful measure of a company’s ability to generate cash returns on its investments.
In principle, this ratio is similar to the ROE ratio, but CROCI is calculated on a cash basis and on an EV-basis, taking into account assets funded by all the company’s security-holders. CROCI is calculated as the internal rate of return in a particular year of a company’s gross post-tax cash flows after investing the gross capital invested over the total asset life of the firm. In principle, this should be equivalent to the ratio of the free cash flow of that year to the net capital invested, provided depreciation is calculated economically and the only capex is for maintenance.[2]
The higher the CROCI, the more the ability of the ability of the company to generate cash and research above from Goldman Sachs shows those companies perform the best.
Risk Warning
Of course there remains a risk warning. I don’t like gambling on how long it will take to issue a vaccine and get it out there. And there is another problem. No measure of a company is fool proof. Add to that that if 75% of people only take the vaccine and it is 90% effective, then we still have a sizeable group, maybe around a third, who are unprotected.
Beware too, that stocks which have lept in the past two days, may see some profit-taking before the strategy of them eventually resuming their pre-lockdown trend resumes.
Which Stocks Don’t Make the Cut
For instance JD Sports, Computacenter, Kainos, does not make our list because it’s already rallied and benefitted from home gym clothes buyers after the initial dip from the virus. That’s not to say those companies may not rise for other reasons not linked to the virus. Here I am looking at virus strategies.
Carnival didn’t make the cut because there are other companies with better financials.
Which Stocks to Rally with the Vaccine? FTSE 350
So with all the above in mind. Which will do well potentially?
From the FTSE 350, I find:
Countryside Properties [CSP], Morgan Sindall [MGNS], 4imprint Group [FOUR],
Which Stocks to Rally with the Vaccine? US Shares 500
And using the same principles these stood out for me in US stocks:
American International Group [AIG], Chubb [CB], CDW, Globe Life [GL], Hartford Financial [HIG], Trandign [TDG].
Which Stocks to Rally with the Vaccine? Nasdaq 100
Here I found Fiserv [FISV]. Again, that’s not to say others wont do well on other strategies.
Alpesh Patel
(I may have holdings in the above before or after the publication of this article)