Ranking Financial Metrics Against Future S&P 500 Index Returns

If you follow equities, you are undoubtedly familiar with the many flavors of financial metrics and ratios (e.g., profit margins, price-to-earnings, price-to-cash flow, dividend yield, and the like) used to describe equity markets. But do any of these indicators have anything to do with future stock returns?

If you’ve ever wondered this, well, you’ve landed in the right place. In this post, we rank the raw correlations for 20 common financial metrics and the S&P 500 Index’s next 12-month return over 372 rolling annual periods from January 1991 through December 2021.  For the punchline, feel free to read on……

Financial Metrics in the Study

The 20 metrics we chose to study can be grouped, by design, to reflect different financial statements (income, balance sheet and cash flow) from which they are derived. We also have one metric, total employees, that is a non-financial statement statistic as shown in the following table.

Study Time Period and Basic Setup

Nothing overly fancy, we just take the raw correlations between each financial metric and then subsequent S&P 500 Index total return for the following 12-months. So, for example, say we take the S&P 500 Index’s profit margin at January 1990, we’ll take that and match it with the S&P 500 Index return over the next 12-months (from January 31, 1990 to January 31, 1991) and repeat the process each month all the way through December 31, 2021.  This gives us a sample of 372 rolling annual periods that we can use for correlations between each metric and the one-year in-the-future S&P 500 Index return.

Ranking Financial Metrics and Future S&P 500 Returns

Now for the punchline. The attached table provides the correlations ranked from positive to negative.  And the winner is……..Free Cash Flow Yield!  

Free cash flow yield showed a positive correlation of 0.36 versus the future 12-month S&P 500 Index return. This indicates that higher free cash flow yields are somewhat linked with positive future S&P 500 Index equity returns. Dividend yield had the next highest positive correlation at 0.32. 

We also need to check for strongly negative correlations since these are useful. Here the standouts are total debt (-0.26 correlation) and price-to-earnings (-0.25 correlation). For these metrics higher numbers are correlated with poor equity returns and vice versa, lower debt and P/Es are correlated with better returns.

The odd thing was how many widely quoted metrics have hardly any correlation to the future year S&P 500 Index returns. In this camp, profit margin, operating margin, earning per share, return on common equity all exhibited close to zero correlation with future year stock returns. And this result is something to think about the next time you hear one of these numbers from a so-called expert!

S.97 and S.98: Free Cash Flow Focused Utility Long Short Screens

So far, 2022 is shaping up to be that rare year when stocks, bonds and most financial sectors (save energy/commodities, of course) are selling off at the same time. There are few places to hide. One strategy that seems partially immunized from all the directional volatility is the sector market neutral (or low net), long short investment approach. Today I look at the utility space and use cash flow focused screens to identify potential “long” and “short” utility companies.   

Sector Long Short

My suspicion is the average investor doesn’t appreciate the fact that in just about all equity sectors (e.g., financials, healthcare, telecom/media, tech) there are influential hedge fund specialists betting long and short on strictly defined sets of companies. 

The basic idea with sector long short is to pick stocks long and short that will have a return spread. If you can correctly identify and invest in a company with a positive return and then short a similar amount of an industry peer that has negative or even less positive return, the investors will earn the spread between the two stocks even while maintaining low overall net exposure to equities! The long and short positions, in terms of market exposure, cancel each other out, and this is why the strategy can be somewhat immunized from the overall direction of the markets.

How do you find these spreads?  Well, that is what takes legwork and many funds seek to identify winners and losers based on fundamental research and other tactics such as triangulating information from industry sources.

To demonstrate how you can identify companies that might offer differing returns I present a simple free cash flow-focused screen for utilities. For the Long portfolio I screen for companies that exhibit a change going from negative-to-positive 12-month free cash flows in the most recent quarter. 

The Short portfolio candidates were the opposite, those going from positive to negative 12-month free cash flows in the most recent quarter. 

S.97: Utilities with Positive FCF Change

Stock UniverseRussell 3000 Index Utilities
Rebalancing FrequencyQuarterly
Screen Criteria12M Free-Cash-Flow>0
12M Free-Cash-Flow Prior QTR <0

S.98: Utilities with Negative FCF Change

Stock UniverseRussell 3000 Index Utilities
Rebalancing FrequencyQuarterly
Screen Criteria12M Free-Cash-Flow<0
12M Free-Cash-Flow Prior QTR >0  


The screen worked, but in the utility industry cash flows are stable so only a few companies made it into either screen and there were many quarters where no companies made it in. Because of this I present the cumulative returns for the last 10 years and the average quarterly return for the long and short portfolios.    

The resulting spread was what we would have hoped: The positive 12 month free cash flow companies outperformed those that had a change to negative 12 month free cash flows in the most recent quarter by an average of 2.7% per quarter. And here is the kicker, for market neutral type sector portfolios, this spread can be leveraged to yield an even greater overall return!  Hope you enjoyed this example and thanks for reading my stuff!

Test Results and Charts

S.95 and S.96: Screening for Retailers with High and Low SG&A Expenses-to-Sales

Today we offer two screens comparing the equity performance of retailers with high and with low selling, general, and administrative expenses. Although it is often said, that retailing is all about location, location, location; for retail stocks, it seems this item called selling, general and administrative expenses is also super important. Let us have a look and see what the data tells us.

The Retail Hi and Lo SGA Screens

If you are retail stock investor or analyst one question you are likely now trying to understand is how retailers are managing costs in the face of historic bout of inflation.  I’ve heard this notion, out in the wilds of the retail analyst community, that retailers with higher costs might have inflation baked into their financials and will outperform those with lower costs who aren’t yet facing the inflation music (this highly counterintuitive thinking can, in my opinion, only come from a mind concerned with guessing the next earnings report to the penny). Although I’m less interested in short-term earnings reports, the idea of investigating the link between selling and admin costs and stock performance over longer periods of time seemed both logical and intriguing.

For the screens, we look at Russell 3000 Index retail industry companies as the starting universe. Next, we make sure they had positive earnings per share to give us a crop of decent retailers, avoiding those in crisis and going out of business. The last part involves searching for retailers with low SG&A-to-Sales by setting this ratio to less than 10%, and then high-cost retailers, by setting SG&A-to-Sales to a ratio above 40%. We rebalance annually and generate the annual returns!

S.95: Lo SG&A/Sales Retailers

Stock UniverseRussell 3000 Index Retail  
Rebalancing FrequencyAnnually
Screen Criteria12M EPS>0
12M SG&A-to-Sales<10%

S.96: Hi SG&A/Sales Retailers

Stock UniverseRussell 3000 Index Retail 
Rebalancing FrequencyAnnually
Screen Criteria12M EPS>0
12M SG&A-to-Sales>40%


Logic prevailed this time around as retailers with Lo SG&A-to-Sales outperformed by a huge margin. Over the 10 calendar years from 2012 through 2021, the Lo SG&A companies outperformed by over 300% on cumulative basis (i.e., 315.4% to be exact). On an annualized basis, the Lo SG&A outperformed the Hi SG&A by 13% per year. Also interesting was the fact that the Hi SG&A retailers actually produced little return over the 10 year stretch (i.e., 39.6% cumulatively) ending 2021. If you are into long/short (e.g., get paid for these ideas) going long low SG&A-to-Sales retailers and shorting high SG&A-to-sales retailers worked amazingly well over the last 10 years and you would have been a well paid hero. This concludes our foray into the world of retail stocks!

Test Results and Chart

S.94: The Facebook Emergency Stock Screen

My friends, every so often, there is an emergency in the equity markets that thrusts us, superhero style, into the melee and requires us to create an equity screen for the public good. Last year, it was GameStop and meme stock mania and this year, almost exactly one year later, the disaster du jour goes by the name of Facebook’s disappointing earnings. 

Facebook’s earnings are positive but they produced a negative surprise and communicated it horrifically which subsequently caused the stock to decline a whopping 26% in one day.  The screen I’ll unwrap in a minute is called the Facebook Emergency Screen, and it is a screen for tech and communication companies with profitable earnings that reported a negative earnings surprise after previously reporting a positive surprise. We really needed, for everyone’s benefit, to see what happens to these companies after they disappoint. And the results, well, they are big surprise!

The Facebook Emergency Screen

Facebook the type of company that leaves investors with that cheap alcohol headache about once a year.  The company has everything you’d want: Earnings, free cash, growing revenues, a not-too-rich valuation, in short, the sort of company whose stock should rise to the moon! The problem though becomes apparent if you’ve ever owned a share, and that problem is that the company communicates strangely with the investor community and compounds this with periodic public relations cluster-disasters.

The typical Facebook playbook is to warn investors that they have a business under pressure and that they will have lower earnings and revenues only to come out later in the year with strong earnings, cash flows, yadda, yadda.  This is the wrong playbook if you are trying to impress investors that count.  The beloved CEOs — the types mutual fund managers adore more than their own kin — are those that promise low growth and eek out low growth plus a small percent on a consistent basis and keep an upbeat attitude through the craziest of times. Consistency in message and delivery is key and, often, this trumps strong revenues and earnings in the eyes of Mr. Mutual Fund.  

Now back to our screen, it is a simple setup. We find large cap tech and communications companies (Facebook is classified as communications and not tech) that exhibit positive earnings; and a recent negative earnings surprise that follows a positive surprise in the prior quarter. That is it. 

S.94: Facebook Emergency Stock Screen

Stock UniverseRussell 1000 Index Communications and Tech
Rebalancing FrequencyQuarterly
Screen CriteriaEPS>0
EPS Surprise Latest <0
EPS Surprise Prior Quarter >0


In the financial markets you can sometimes fall into a trash heap and find a gold watch, and with this screen we’ve stumbled on some gold. Golden returns that is and better than anything I could have imagined. You see I was expected bad results here and what this screen delivered was a 515% cumulative return over the 10 years 2012 through 2021! This equates to 19.9% per year annualized return, which outperformed the Russell 1000 Index  by 3.4% per year. Sure, large cap tech was doing fine and this has some influence in the returns, but anything that compounds at about 20% per year over 10-years is pretty decent! The data does lead me to conclude, that for tech and communications companies, a bad earnings surprise, may not be so bad and that Facebook’s share price may yet have some surprises left to dish out.

Test Results and Chart

S.93: Looking for Losers

One of the hardest things to do in finance is to make money betting against bad companies. Although this may sound backwards, anyone who tries short selling equities, eventually reaches this conclusion.

Since I guess I am of the masochistic variety, I’ve collected the strange hobby of creating and testing equity screens to find bad companies. And so, today I’ll share my latest installment (the 14th if your counting) of screens searching for loser companies with seriously bad financials that might make for good short sale candidates (if you are into that sort of thing). 

The Many Flavors of Loserdom

Short selling involves finding a company that has a problem. The problem can come in near limitless flavors since it can be whatever negative attribute you can imagine. The most obvious is high valuation, but most the time, short sellers look for more than just high valuations and the more negative attributes the better. Toxic CEOs who inflate earnings, obsolete products, outright criminal activities are some of the juicier storylines that short sellers come up with and, if aggressive, will write up in thickly padded research reports (very likely in between pit stops to Eastern Long Island nightclubs). 

Since I am more of a numbers-person than private investigator, I’ve focused for screening for companies with bad financials (e.g., bad margins, earnings, and high balance sheet leverage) that potentially could flame out. The indicator I test in today’s screen is operating cash flow.

I look for companies with 12 month negative operating cash flow relative to assets, which is an indicator of a bad business operation.  To top it off, I add the kicker condition that this ratio is becoming more negative (worse) year-over-year and that earnings per share is also negative!  Let’s see how this crop of “losers” performed over the last 10 years. (Note: I avoid including biotechs since they operate differently, losing money is part of the proposition until drugs get through approvals.)

S.93: Loser Company Screen

Stock UniverseRussell 3000 Index ex Biotech
Rebalancing FrequencyQuarterly
Screen CriteriaOperating Cash Flow/Assets<0
Operating Cash Flow/Assets YoY <0


Have I mentioned it is hard to make money short selling loser companies?  Yes, and the results here prove it again. Shorting companies with negative, worsening,  operating cash flows seems like a great idea, the only problem, a portfolio of these companies would have returned 113.9% cumulatively over the 10 years ending 2021! That illustrates the downside of short selling.

As a screen this is pretty great since it yielded a portfolio that underperformed the Russell 3000 Index in seven out of the last 10 years and by close to 10% per year (9.6% to be exact). If you were a hedge funder getting paid to spot underperforming companies this type of result would have made you some decent bonuses especially during the period 2014, 2015 and 2016, since the so called “short alpha” was huge!  This concludes our trip to loserland!

Test Results and Chart

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