Going for growth: 'A hard strategy to stick with'

What are we looking for?

Canadian growth stocks that are trading at a reasonable price.

More about today's screen

With the help of Morningstar CPMS, we'll look for stocks that have a high return on equity, yet a low price-to-earnings ratio based on current year expectations.

We'll screen out stocks with high dividend yields, as we're looking for companies that are successfully investing their capital for growth. (A high yield can be a sign that a stock is unloved and must offer a bigger payout to woo investors.) Dividend yields must be below the median yield of the S&P/TSX composite, which is now 3 per cent, and dividend payout ratios (dividend over EPS) must be below 25 per cent.

Stocks must also demonstrate growth over the long term. Five-year sales growth and five-year earnings growth, annualized, must be greater than zero.

More about Morningstar 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?

Jamie Hynes, a senior consultant with CPMS, created a portfolio based on this screen of the Canadian stocks his firm covers, updating it on March 31 every year for the past 20 years. Annualized, it produced returns of 13 per cent versus 9.7 per cent for the S&P/TSX total return benchmark index over the past 20 years.

"This is another example of how powerful a disciplined investment strategy is over the long-term when constructed properly," Mr. Hynes said. "In hindsight it looks easy, but the tough part on a day-to-day basis is staying disciplined."

For example, this model underperformed by almost 20 per cent from 1999 to 2000 and by 23 per cent from 2008 to 2009 (including a 45-per-cent loss in 2009), he said.

"A look at the current portfolio also reveals why this would be a hard strategy to stick with," he said. "Grande Cache Coal and Research In Motion were the top-ranking stocks selected on March 31, but are down 21 per cent and 16 per cent, respectively, over the one month since."