Thursday, 24 May 2012

Purple Chips - Yet Another Angle to Finding Good Stocks

We've spent the last several posts looking for solid equity stocks amongst those with low volatility compared to the overall market. Now along comes another approach called Purple Chips to give us another perspective. Interestingly there is a considerable overlap of the conclusions.

Purple Chips is the name created by investment advisor John Schwinghamer to describe the cream of the crop of blue chip stocks. His criteria for inclusion is quite stringent: a minimum of seven years of smooth, predictable, positive and rising earnings per share. To ensure stability - he likens to the difference between an ocean liner and a small boat - he further restricts stocks to large companies, those with a market cap of shares outstanding of at least $1 billion. Schwinghamer explains his method in detail in his recently published book with the title, what else could it be, Purple Chips.

In addition to identifying the solid performers, he has developed a simple method for determining whether the stock price at any given time is cheap or expensive. Based on the relationship between Earnings per Share (EPS) and stock price, the method adjusts for changing market conditions from bull markets, when the market is willing to pay more for each dollar of earnings, to bear markets, such as nowadays, when the market sees risk everywhere and isn't willing to pay much for earnings. Conveniently for those investors who just want to see the results, he has created the website where the US and Canadian Purple Chip stocks are listed along with the current under- (stocks to buy) or over-valued (stocks to sell) price assessments. The website lists 41 Canadian and 233 US Purple Chips. Let's see how his Canadian list compares with the low volatility stocks we've recently examined.

Lots of overlap between Purple Chips and Low Volatility Stocks
More than half - 26 of 49 - the stocks in one or the other of the two low volatility Canadian equity ETFs (PowerShares S&P/TSX Composite Low Volatility Index ETF (TSX: TLV) and BMO Low Volatility Canadian Equity ETF (TSX: ZLB) we posted about here show up in Schwinghamer's Purple Chips list too. It's gratifying and reassuring to find that stocks with a relatively stable market price should also be steadily profitable.The table below shows which holdings of TLV and ZLB overlap with the Purple Chips, along with the indicator as to whether each stock is currently over- or under-priced (cells bordered by either red for over-valued or green for under-valued).

Less convergence on which ones are Under-Valued Buy Stocks
Of our Top 10 Picks in last week's post, only two stocks are rated a Buy, and a weak Buy at that, on the Purple Chips website - Metro Inc (TSX: MRU) and Rogers Communications (TSX: RCI.B). Two of our Top 10 are rated the opposite as slightly over-valued by Purple Chips - Shoppers Drug Mart (TSX: SC) and Astral Media (TSX: ACM.A). The rest are in the middle, more or less fairly valued.

The disagreement on value is a good reminder that all our assessment methods are based on past data. The future may not be like the past so our seemingly sure stock picks may not work out as well as we hope. Schwinghamer warns us too that his method works on average over a large number of stocks and with a rigorous buy-sell discipline maintained over years through all sorts of market conditions. With each individual stock the investor has a good chance of making money but not a certainty.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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