What are we looking for?
A concentrated Canadian portfolio showing growth and momentum across most economic sectors.
The screen
This week, I use Morningstar CPMS to develop a strategy that looks for companies with positive price momentum, but that are also supported by fundamental growth and profitability. This strategy contrasts with what happened last year in Canada, with companies showing positive price momentum not supported by fundamental growth (a consequence of the cyclical nature of the Canadian equity markets). The strategy ranks stocks on the following factors:
- Forward return on equity (a profitability metric that helps to understand how the book value of equity is growing – higher values preferred);
- Three-, six- and nine-month price changes (these traits show positive price momentum);
To qualify, companies must have a debt-to-equity ratio equal to or less than the median of the sector to which it belongs (to avoid overly leveraged companies). In the accompanying table, a figure of 1.0 shows the company's debt-to-equity ratio is equal to the sector median. A figure less than 1.0 shows the company's debt-to-equity ratio is less than that of the median.
Stocks were also screened to ensure at least three analysts are actively covering the stock. Just a single company from each economic sector was considered. (Only nine of 11 sectors currently meet my screening requirement.) Lastly, to ensure reasonable liquidity, only companies that trade, on average, at least one million shares a month 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 Morningstar CPMS to backtest this strategy from December, 1991, to February, 2017. During this process, a maximum of 11 stocks were purchased with a maximum of one stock per economic sector. Stocks were sold if their rank fell below the top 30 per cent of the universe. (At present, the CPMS Canadian universe consists of roughly 720 companies.) When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio, keeping in mind the aforementioned sector limits. Over this period, the strategy produced an annualized total return of 16.3 per cent while the S&P/TSX total return index advanced 8.6 per cent. The stocks that qualify for purchase today 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.