Here Are 10 Materials Stocks That Can Outperform The Sector
Consistently choosing winners is hard. But staying objective and consistent in “how you choose” can sometimes produce alpha and give you an edge.
Here is one such selection strategy. These 10 stocks – for their valuation level – have no other sector peers that have lower valuation but offer better growth (across all 3 periods – quarterly, last 12 months, and last 3-year average) and better cash flow margins (3-year average). We call them the Best Bets.
| Best Bets In Materials Sector | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| USLM | SCCO | CF | EXP | BCPC | NEU | ESI | NEM | REYN | CBT | |
| P/E | 28.3 | 28.0 | 11.5 | 16.7 | 32.0 | 16.9 | 26.6 | 15.4 | 16.8 | 9.2 |
| P/EBIT | 24.5 | 16.7 | 7.3 | 12.2 | 23.1 | 12.2 | 16.9 | 10.7 | 9.9 | 5.9 |
| Rev Chg Q | 19.6% | 20.1% | 20.2% | 4.3% | 9.1% | 0.6% | 2.0% | 20.8% | 0.9% | -9.2% |
| Rev Chg LTM | 22.0% | 23.2% | 9.5% | 0.9% | 5.7% | 3.7% | 5.4% | 38.4% | -0.5% | -3.6% |
| Rev Chg 3Y Avg | 19.1% | 3.3% | -12.4% | 5.6% | 4.1% | 4.7% | -1.5% | 20.6% | 0.0% | -2.5% |
| FCF/Rev 3Y Avg | 24.7% | 23.7% | 21.3% | 17.5% | 14.6% | 14.0% | 11.7% | 11.0% | 9.1% | 8.9% |
[1] Choosing top 10 best bets from each sector quarterly is an alpha producing strategy vs sector benchmark
[2] Historical annualized return of 8.7%, alpha of 0.1%, and sharpe of 0.39
This is an effective way to look at stocks. When you invest, your are making a purchase and you would ofcourse want most out of the price you are paying. And that is exactly why this works. But when it comes to a sophisticated portfolio – this becomes just one of the perspectives. We blend in a lot more – combining diversification across equity factors with multi-asset allocation strategy. Trefis works with Empirical Asset Management – a Boston area wealth manager – whose asset allocation strategies yielded positive returns during the 2008-09 period when the S&P lost more than 40%. Empirical has incorporated the Trefis HQ Portfolio in this asset allocation framework to provide clients better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics.
How Do We Choose?
We search the entire sector and for each stock, we try to find other stocks in the sector that have lower valuation but higher revenue growth and higher cash generative capacity.
If there are no such alternatives, we call the stock in question as one of the “best bets”. We then filter top 10 best bets based on free cash flow margins.
[1] We use P/E and P/EBIT ratios as measure of valuation.
[2] For revenue growth, we check last quarter, last 12 months, and average of last 3 years.
[3] Finally, we use last 3 years’ average free cash flow margin as measure of cash generative capacity.
How Well This Selection Works?
Based on rigorous backtest spanning nearly a decade, choosing such bets and holding them for at least a quarter, turns out to be a valid portfolio strategy that can beat the sectoral index XLB
The stats below for the period 12/31/2016 to 6/30/2025
| Value | |
|---|---|
| Annualized Return | 8.7% |
| Alpha | 0.1% |
| Sharpe Ratio | 0.4 |
| Beta | 1.0 |
| Pct Months +ve Return | 61.8% |
The Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has a track record of comfortably outperforming its benchmark that includes all 3 – the S&P 500, S&P mid-cap, and Russell 2000 indices. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics.