What are we looking for?
Mid- and small-cap stocks on the rise outside of the S&P/TSX composite index.
The screen
For investors able to work with the liquidity constraints that come with investing in mid-/small-cap names in Canada, this week's strategy shines a light on names that have shown a relatively stable history of earnings growth, and have also seen positive short-term growth in earnings.
To find these stocks, I've ranked the CPMS universe based on the best combination of the following factors:
– earnings variability (which looks at the full history of each company's reported earnings and tracks how consistent they are over time; lower scores are preferred);
– five-year earnings growth rate;
– quarterly earnings momentum (latest four quarters of reported earnings, compared against the same figure one quarter ago);
– three-month price momentum (average price over the past six months, compared against the same figure three months ago).
To qualify, stocks must not be part of the S&P/TSX composite index and must have a market cap of $300-million or more. I find that TSX stocks outside the composite tend to fall below the radar of the typical investor, yet could provide some good opportunities for medium- or long-term growth.
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 May, 2002, to November, 2015. During this process, 10 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 40 per cent of the ranked universe, or if the price fell by more than 15 per cent over the trailing 90 trading days.
Over this period, the strategy generated an annualized total return of 20.9 per cent while the BMO Nesbitt Burns small-cap total return index produced 5.1 per cent. Today, only nine stocks qualify to be bought into the strategy and are listed in the accompanying 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.