What are we looking for?
Wednesday’s column, looking at Brockhouse Cooper’s screen for “quality” stocks on the S&P 500, generated plenty of reader interest. “Nice stuff,” they said, “but what about Canadian stocks?”
A fair question. So today, we’ve replicated (as best we could) Brockhouse Cooper’s U.S. screen to identify the highest-quality stocks on Toronto’s benchmark S&P/TSX composite index.
The quality screen – Canadian style
Brockhouse Cooper’s research team, led by global macro strategist Pierre Lapointe, has defined “quality” as stocks with high return on equity, low debt leverage and low earnings volatility. They argue that since the Great Recession, stocks with these qualities have substantially outperformed the two most popular investing strategies in the equity market – growth stocks and value stocks. And, they say, the best returns over the past three years seem to have had little correlation with either stock valuations or earnings-growth expectations.
Mr. Lapointe’s team came up with a screen for stock quality that centres on ROE – annual net income expressed as a percentage of total shareholder equity. ROE essentially measures profits relative to the size of the total investment in the company – a good way to assess how much investors are getting for their money.
Brockhouse Cooper screened for ROEs of more than 15 per cent. It also screened to ROE volatility – requiring that each stock have a six-year variation of ROE of less than 10 per cent. It also screened for stocks with a debt-to-common-equity ratio of less than 50 per cent.
Using the stock-screening tools of S&P Capital IQ, we built a screen with similar criteria – ROE of more than 15 per cent, debt-to-equity of less than 50 per cent, six-year ROE standard deviation of less than 10 per cent.
What we found
Our Canadian version of the screen revealed just 14 S&P/TSX composite companies that cleared the bar on all three criteria. We’ve sorted them by highest ROE over the past 12 months.
Topping the list was Nevsun Resources Ltd., a gold and base-metals mining and exploration company focused on Africa. Not only can it boast the highest ROE on the S&P/TSX composite, but its debt-to-equity and ROE volatility are also toward the low end of the companies that passed the screen.
As always, though, investors should approach these screens with caution. For example, Canadian Oil Sands Ltd. is near the top of the list – yet some quick research reveals that the company’s 37-per-cent-owned Syncrude oil sands operation has been suffering operating problems that have reduced production and pushed up costs. The screen is a good starting point, but always do some additional digging into a company’s story and its stock performance before making your investment decision.