What are we looking for?
Companies that have surpassed analyst expectations in the most recent quarter of reported earnings.
The screen
At this point in the quarter, roughly two-thirds of the stocks on the S&P/TSX composite index have reported their latest quarter of earnings. Companies that surprise analysts often show positive price momentum after the report date as the market adjusts to new information. Recall that the earnings surprise is measured as the percentage difference between the latest consensus estimate from analysts just prior to the company reporting and the actual results.
This being said, not all investors will find large positive surprises desirable as they add additional volatility to the overall portfolio. This week, I revisit a two-factor strategy that ranks stocks based on the best combination of the latest earnings surprise and the five-year price beta against the S&P/TSX composite index. The goal of this strategy is to find stocks that show positive earnings surprises but also have exhibited low sensitivity to market movements historically. Remember, a stock with a beta of one has a historical tendency to move in line with the market during trending periods, while stocks with a beta less than one have moved less than the market during trending periods.
The strategy only considered stocks that are part of the S&P/TSX composite index and have at least three analysts actively covering the company.
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 December, 1991, to July, 2015.
During this process, 10 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 50 per cent of the ranked universe. Over this period, the strategy produced an annualized total return of 18.5 per cent, while the S&P/TSX total return index produced 8.7 per cent.
The top 10 qualifying stocks are listed in the table along with their next reporting date.
As always, investors are advised to conduct their own independent research before purchasing shares in the companies shown.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.