Beware of These Dogs

S&P's latest screen finds 10 outfits that score poorly in four key categories. Among them: Eastman Kodak and Qwest Communications

by Michael Kaye From Standard & Poor's Equity Research

We've said it before, and we'll say it again: It can be just as important to know which stocks Standard & Poor's Equity Research doesn't recommend as it is to know which stocks we do recommend. After all, as they say in baseball, sometimes the best trades are the ones you don't make.

How do we separate the wheat from the chaff? We maintain a number of proprietary investing metrics focusing on both qualitative and quantitative approaches. For this week's screen, we looked for stocks that are ranked poorly by three proprietary S&P Equity Research metrics and a fourth metric borrowed from our colleagues on the ratings side of S&P.

We began by looking to the STARS—S&P's STock Appreciation Ranking System. Under STARS, S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential vs. the expected performance of a relevant benchmark (in the case of U.S. stocks, the S&P 500 index). We looked for those stocks ranked 2 STARS (sell) or 1 STARS (strong sell), meaning that they're expected to underperform the S&P 500 on a total return basis over the next 12 months.

Looking for Low Grades

Next stop: our Fair Value model, a quantitative stock ranking system. The model calculates a stock's weekly Fair Value—the price at which it should trade at current market levels—based on fundamental data such as corporate earnings and growth potential, return on equity, current yield relative to the S&P 500, and price-to-book value. Stocks are ranked from 5, indicating significant undervaluation, to 1, indicating significant overvaluation. We sifted for those issues ranked 2 or 1, indicating they're overvalued vs. the Fair Value universe.

But we wanted to give investors a couple more reasons not to own these stocks. So we added requirements that the stocks must carry an S&P Quality Ranking of B- or below. An S&P Quality Ranking is our measure of common stocks based mainly on long-term earnings and dividend performance.

For our final filter, we checked up on the companies' credit scores by turning to data from S&P Ratings Services (S&P Ratings operates independently of S&P Equity Research). While an S&P credit rating isn't meant to represent an opinion on a company's worthiness as an investment, it can be an indicator of its financial health. The stocks had to carry a rating of BBB+ or below.

Only stocks that were ranked in each of the four systems were included. Ten stocks emerged, including well-known names such as Kodak and Qwest Communications.

Kaye, a chartered financial analyst, is an analyst for Standard & Poor's Portfolio Services. He is the author of The Standard & Poor's Guide to the Perfect Portfolio: Five Steps to Allocate Your Assets and Ensure a Lifetime of Wealth.