What are we looking for?
Canadian companies with a solid growth outlook and improving profitability.
More about today's screen
Craig McGee, senior consultant at CPMS Morningstar Canada, created a screen to look for growth companies with a brightening profit outlook. He ranked 721 Canadian firms and selected the top 20 stocks with a market cap greater than $500-million. To guard against too much focus on any single industry, he allowed no more than five stocks from any one sector.
The criteria he examined were:
-four-year average return on equity (ROE) using 2013, 2012, 2011 consensus earnings per share (EPS) and 2010 reported EPS;
-three-month consensus 2012 EPS estimate revisions;
-Annual rate of change of ROE (latest reported 12-month ROE versus ROE from four quarters before);
-Annual rate of change of EPS (latest reported 12-month EPS versus. EPS from four quarters before);
-Annual rate of change of revenue (latest reported 12-month revenue versus revenue from four quarters before);
-Annual rate of change of operating cash flow (latest reported 12-month CF versus CF from four quarters before);
-Change in net margin (latest reported 12-month EPS/sales minus EPS/sales from four quarters before).
More about CPMS
CPMS, a division of Morningstar Canada, provides quantitative North American equity research and portfolio analysis to primarily institutional clients. It covers more than 700 Canadian and 2,200 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?
"When searching for capital gains potential, improving levels of profitability and growing expectations can be important catalysts for growth," says Mr. McGee. His back test, beginning in 2003, selected the best 20 qualifying stocks every quarter-end and held the portfolio for the next three months.
The simulated portfolio produced an annualized return of 24.2 per cent, compared to 9.9 per cent for the S&P/TSX Total Return Index over the same period. It outperformed the index every year except for the crash in 2008, where it lost 45 per cent.
Tempting as the results look, investors should also factor in the constant supervision required to follow this strategy, as well as substantial trading costs. "Since we reselected every quarter, average annual turnover of the strategy was also very high at 246 per cent so it would require a close watch to follow on an ongoing basis," Mr. McGee says.
footnotes to table
Grades relative to 721 Canadian stocks in the CPMS universe (A = best, E = worst). Source: Morningstar Canada
Ian McGugan