Value Line's List of Stocks with the Highest Potential Total Returns

Each week Value Line publishes a list of the stocks having the highest potential 3- to 5-year total returns (price movement plus dividends). Value Line's proprietary models are quantitative and based largely, if not entirely, on historical company financials and valuation ratios. Companies with rapidly rising revenue and earnings and a recently depressed stock price are typically the ones that appear on Value Line's list of stocks with the highest potential returns.

As a spot check to see if the high total returns actually materialize five years out, I tracked the stock price performance of the top 10 companies on the lists from February and August of 2000. Below I summarize what I found:

Tables show for each company: Value Line Potential Annual Return, Actual Annual Return, $100 Investment Becomes

Value Line Publication Date: February 18, 2000

Action Performance (ATN): 59%, 12%, $175
Topps (TOPP): 58%, 6%, $135
Tokheim Corp.: 56%, -73%, $0
Federal Mogul: 55%, -52%, $2
Oregon Steel Mills (OS): 55%, 44%, $626
Heilig Meyers: 54%, -81%, $0
Burlington Inds.: 52%, -100%, $0
theglobe.com: 52%, -51%, $3
R.G. Barry (RGBC.OB): 51%, 4%, $125
Oakwood Homes: 50%, -55%, $2

Period: February 18, 2000 to March 2, 2005
Annual Portfolio Return: 1.3% ($1000 grows to $1070)
Annual S&P 500 Return: -2.1% ($1000 shrinks to $900)
Difference: 3.4%

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Value Line Publication Date: August 18, 2000

Action Performance (ATN): 81%, 29%, $314
theglobe.com: 81%, -30%, $20
Oakwood Homes: 76%, -53%, $3
Service Corp. International (SCI): 73%, 31%, $346
Navigant Consulting (NCI): 70%, 54%, $715
Burlington Inds.: 68%, -100%, $0
Federal Mogul: 66%, -52%, $3
Gerber Scientific (GRB): 66%, -6%, $76
QAD (QADI): 64%, 23%, $252
Free Markets: 64%, -100%, $0

Period: August 18, 2000 to March 2, 2005
Annual Portfolio Return: 12.8% ($1000 grows to $1730)
Annual S&P 500 Return: -4.5% ($1000 shrinks to $810)
Difference: 17.3%

Ticker symbols are shown in parentheses for companies whose shares are still actively trading today. The companies for which ticker symbols are not shown have been de-listed, presumably following poor financial results that led to large declines in share price. Among the Feb-2000 group, only 4 of the 10 companies are now in sound financial condition. From the Aug-2000 group, 5 of the 10 companies are survivors.

What is most interesting about the results is that, although only about half of the companies avoided de-listing over the 5 years following publication of the Value Line lists, both the Feb-2000 list and the Aug-2000 list outperformed the S&P 500, beating the market index by 3.4 and 17.3 percentage points, respectively.

Based on such small sample sizes, it is difficult to draw statistically significant conclusions. However, I suspect that the outperformance of the portfolios over the S&P 500 could be a real effect, attributable to the geometric return pattern I discussed in a prior post. See "Merits of Volatility in a Portfolio," January 29, 2005:
http://lloydsinvestment.blogspot.com/2005_01_01_lloydsinvestment_archive.html

The basic idea is that, in a portfolio with many volatile components, the winners more than make up for the losers. The value of a stock with a 40% annual return grows to 5.4 times its original value over 5 years. A stock with a 50% annual return grows 7.6 times in 5 years. In a portfolio holding 10 stocks, one 40% winner, one 11% return, three 0% returns and five completely bankrupt losers is all that is needed to produce a positive portfolio return. Having two 50% winners, two 25% returns, two 12.5% returns, and four bankruptcies will give a very attractive 20% annual portfolio return.

The February 18, 2005 issue of Value Line lists the following stocks with the highest 3- to 5-year potential total returns:

Company (Ticker): Value Line Potential Annual Return

UTStarcom (UTSI): 54%
Conextant Systems (CNXT): 51%
Anadigics (ANAD): 48%
Nuance Communications (NUAN): 44%
Three-Five Systems (TFS): 44%
AMR (AMR): 43%
Adaptec (ADPT): 43%
Delta Air Lines (DAL): 43%
Lattice Semiconductor (LSCC): 43%
webMethods (WEBM): 43%

As was the case with the groups of stocks from the year 2000 that we looked at, it will most likely turn out that only one or two of these 10 companies end up actually providing the indicated potential returns, and half of the companies will probably become de-listed or go bankrupt. However, it could also very well turn out that this portfolio of volatile stocks ends up handily beating the market. I look forward to returning to check up on this group of stocks five years from now in 2010.

(Disclosure: I have a small long position in UTSI, a telecommunications equipment provider active in China that is diversifying its revenue stream globally. When I bought my shares last year, I was aware that Softbank was the largest shareholder of record. Recently, I learned that the Bill and Melinda Gates Foundation bought 1.7 million shares last year.)