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What are we looking for?
Stocks that wear a triple crown – for strong momentum, impressive profitability, and cheapness relative to sales.
How we did it
Craig McGee, senior consultant at CPMS Morningstar Canada, filtered the CPMS Canadian database for the 20 stocks with the best combination of three factors:
-Their enterprise value in comparison to their latest four quarters of sales (EV/S): Enterprise value is the value of a company's equity plus its total debt less cash and equivalents. A company that has high sales relative to its enterprise value may be undervalued.
-Return on invested capital (ROIC): This is calculated by dividing earnings before interest and taxes (EBIT) by the average level of debt and equity in the company. ROIC is a good measure of how efficiently a company is using the money invested in it.
-The price change over the past 12 months. Companies with strongly rising prices often keep on going up.
Mr. McGee required each company's EV/S to be in the lowest half of all values, and its ROIC to be in the highest half of all values.
He also required that any revisions over the past three months in analysts' consensus earnings estimates, as well as earnings surprises, be flat or positive. As well, companies had to have a market cap greater than $500-million.
To ensure adequate diversification, he permitted no more than four stocks from any single sector.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.
What we found
To measure the strategy's effectiveness, Mr. McGee ran a simulation of how it would have performed from Jan. 1, 2002, to the end of May, 2013. Each stock was held until its ranking fell out of the top 40 per cent, at which point it was replaced by the next best ranking stock.
The strategy thumped the TSX total return index, returning 16.7 per cent a year compared with the index's 7.1 per cent. Remember, though, that past performance doesn't guarantee future results. Do your own research before buying any of the stocks listed here.
Ian McGugan