Craig McGee is a senior consultant at Morningstar Canada.
What we're looking for
In the potentially overheated U.S. market, high-quality stocks trading at cheaper valuations are hard to come by.
Using Morningstar CPMS, I looked for U.S. stocks with reasonable valuations that also provide solid growth and profitability while generating revenue efficiently.
The screen
Specifically, I ranked the CPMS U.S. database for the top 20 stocks with the best combination of the following metrics:
- Earnings yield (latest four quarters’ EPS divided by latest price);
- Five-year EPS growth rate;
- Return on equity (latest four quarters);
- Asset turnover (latest four quarters’ sales divided by total assets);
- Revision of the current year’s consensus EPS estimate over the past three months.
Stocks with a negative 30-day price change were excluded as were stocks with an average trading volume of less than $2-million a day.
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.
What we found
To test how repeatable this process has been, I used the CPMS back-test to pick an initial portfolio of 20 equally weighted stocks using the above criteria back on Dec. 31, 1993. Stocks were then re-ranked monthly and would be replaced if they fell outside of the top 30 per cent.
Since inception, this approach would have generated an annualized total return of 17.4 per cent while the S&P 500 total return index posted a return of 9.2 per cent. In the 12 months ended Feb. 28, 2014, the model's return was 42.7 per cent compared with 25.4 per cent for the index.