What are we looking for?
Stocks with strong upward momentum characteristics while trading at a discount compared with historical multiples.
The screen
After three consecutive quarters of negative returns, the S&P/TSX composite has produced 4.5 per cent for investors in the first quarter of 2016. More impressively, the index has delivered more than 17 per cent since it last bottomed out on Jan. 20. In March, 80 per cent of stocks on the index advanced for the month, up from a meagre 38 per cent in January. All these stats suggest positive market momentum and if that momentum is real, investors may be able to capitalize and ride the upward trend.
Today I use Morningstar CPMS to look for stocks experiencing positive momentum in earnings, cash flow, price change and analyst estimate revisions. Factors used to rank stocks in this strategy include:
- Three-month analyst earnings-per-share revisions (the difference between current median consensus EPS estimate with the same figure three months ago);
- Quarterly earnings momentum (rate of change of quarterly operating earnings, that is, latest four quarters versus the same figure one quarter ago) and quarterly cash flow momentum (the same rate of change);
- Three- and six-month price change;
- Quarterly earnings surprise (a proprietary measure of the difference between actual and expected earnings for the latest reported quarter).
Stocks are only purchased in the strategy if they have a traded dollar value of at least $2-million in the past calendar month to ensure they are not thinly traded stocks, which pose higher risk and are susceptible to volatile price swings. Also, stocks must be trading at least 0.5 per cent above their three-month average closing price. Finally, stocks must be trading at a discount when compared with their historical price-to-earnings and price-to-book multiples.
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 February, 2001, to March, 2016. During this process, a maximum of 10 stocks were purchased and equally weighted with a maximum of five stocks a sector. Stocks would be sold if they fell outside the top 40 per cent of the ranked universe, if the stock price fell more than 0.5 per cent below its three-month average price, or if the stock rose above 1.5 times its historical price-to-earnings or price-to-book multiple. The portfolio is rebalanced quarterly. Over this period, the strategy produced an annualized total return of 24.6 per cent while the S&P/TSX composite total return index advanced 6.1 per cent. Today, 10 stocks qualify for purchase 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.
Michael Pe, CFA, is an institutional product specialist for CPMS at Morningstar Research Inc.