What are we looking for?
A core, diversified portfolio representative of most Canadian sectors.
The screen
This week, I use Morningstar CPMS to create a portfolio designed to reflect most sectors of the Canadian economy, using a maximum of 11 stocks (one a sector).
The strategy ranks stocks on the best combination of the following factors:
- Quarterly earnings momentum (the trailing four quarters of reported earnings, compared with the same figure one quarter ago);
- Quarterly earnings surprise (the latest reported earnings compared with the consensus estimate just prior to the stock reporting);
- Latest reported return on equity, and the average return on the equity over the past 10 years;
- Standard deviation of returns over the past 300 days (this is a measure of the stock’s volatility over the past 300 days – lower figures are preferred here);
- Price-to-book, price-to-sales and price-to-earnings ratios.
To qualify, stocks must have a debt-to-equity ratio less than the median of the S&P/TSX composite index (today this figure is 0.53), and a cash flow to debt ratio greater than the median of the S&P/TSX composite index (today this figure is 0.32). Only companies included in the S&P/TSX were considered.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its 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. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used CPMS to back-test the strategy from January, 1999, to August, 2016.
During this process, a maximum of 11 stocks were purchased and equally weighted with a maximum of one stock a sector.
At the end of each calendar year, the portfolio was replaced with a new set of top-ranked stocks, again with a maximum of 11 stocks.
Over this period, the strategy produced an annualized total return of 11.8 per cent while the S&P/TSX composite total return index advanced 7 per cent.
The nine stocks that qualify for purchase today are listed in the table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.