Craig McGee is a senior consultant at Morningstar Canada.
What are we looking for?
Today, we’ll look for Canadian large-cap companies with valuations and profitability better than industry peers – and with growing expectations from the Street.
Specifically, I used CPMS to filter for the 100 largest Canadian stocks based on market cap and ranked the universe to find companies with the best combination of the following metrics:
- industry-relative price-to-forward earnings (values must be less than the industry median);
- industry-relative return on capital (return on capital is calculated as earnings before interest and taxes for the trailing four quarters divided by capital – or the average debt and equity over the same period) where values must be greater than the industry median;
- one-year relative strength (measuring price performance relative to all other CPMS stocks where 99 is best, 0 is the worst);
- three-month relative strength.
Stocks must also have positive revisions to the consensus earnings estimate over the past three months. No more than two stocks were allowed per sector.
More about Morningstar
Morningstar 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
Using CPMS, I back-tested the strategy to apply the same rules-based approach beginning Dec. 31, 2001. A portfolio of up to 15 stocks was equally weighted and each quarter the database was reranked. Stocks would be held until they fell outside of the top 50 per cent, at which point they would be replaced with the top-ranking stock available.
Over the full time period, the strategy generated an annualized total return of 14.2 per cent versus 8.0 per cent for the S&P/TSX Composite Total Return Index. In the 12 months ended March 31, 2014, the strategy posted a return of 26.3 per cent while the benchmark came in with 16.0 per cent.