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Number Cruncher

A balancing act, for good times and bad Add to ...

What are we looking for?

The best of income and growth Canadian stocks.

More about today’s screen

This is the culmination of the last two screens we’ve done with Morningstar CPMS. The first one was for income stocks and the second one for asset growth stocks. Today’s screen combines the two strategies into one balanced portfolio.

The income part of the portfolio looks for stocks that:

- have a dividend yield greater than the bottom quarter of dividend-paying stocks;

- are growing dividends by at least 2 per cent a year over the last five years or are expected to grow dividends by at least 10 per cent year-over-year;

- have a dividend payout ratios of less than 80 per cent of forward earnings or 50 per cent of trailing cash flows in dividends;

It then ranks the stocks by:

- dividend yield;

- five-year dividend growth;

- expected dividend growth (forward versus trailing four quarters);

- cash flow growth;

- profitability as measured by return on equity.

The asset growth part of the portfolio looks for stocks that have:

- a high reinvestment rate on both an historical and estimated future basis, as defined by earnings per share minus dividends per share divided by book value;

- rising forward earnings estimates during the last three months;

- positive earning surprises in the last quarter;

- sales growth in the last four quarters versus the previous four quarters.

More about CPMS

CPMS is an equity research and portfolio analysis firm owned by Morningstar Canada. It maintains a database of about 680 of the largest and more liquid Canadian stocks, plus another 2,100 U.S. stocks, and spends a lot of time adjusting for unusual accounting items in each company’s quarterly results to make sure screens can perform correctly.

What did we find out?

As we learned the past two weeks, both portfolios perform well on their own, but have disadvantages. The income portfolio is less volatile and holds up well when markets are falling, but it tends to lag when markets are rising. The asset growth portfolio is the opposite, so combining the two should work well. Let’s see.

Jamie Hynes, senior consultant with CPMS, ran the numbers on a portfolio of 10 income and 10 asset growth stocks back to 1991. Stocks were selected from the largest 250 on the TSX by market flow. Mr. Hynes found the portfolio returned 17.6 per cent annualized, versus 9.7 per cent for the S&P/TSX composite total return index.

The strategy also does indeed hold up well in down markets and outperforms in rising markets.

Mr. Hynes said the portfolio underperformed by just 1.7 percentage points in 2008 (minus 34.7 per cent versus minus 33.0 per cent), but bounced back strongly in 2009 to beat the TSX benchmark by 7.3 per cent percentage points (42.4 per cent versus 35.1 per cent). “This model offers investors a balanced approach to equity exposure in just a 20-stock portfolio,” he said.


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