What are we looking for?
Value stocks that are not carrying high debt levels and are less sensitive to interest rates hikes.
The screen
As this year is coming to an end, investors turn their focus to their investment strategies for next year, trying to prepare for market trends that might occur.
The Federal Reserve boosted the key rate by a quarter percentage point in December, with many anticipating the trend to continue next year. While the Bank of Canada has not followed suit yet, that might very well change in 2017. With that in mind, I wanted to identify potential value buys that at the same time have low sensitivity to interest-rate increases. To achieve that, I focused on stocks that carry low levels of debt and generate sufficient earnings to pay their interest.
I used CPMS to build a strategy that ranks stocks based on the best combination of:
- Three-month analyst estimate revisions (current consensus estimate for EPS vs. three months ago);
- Price-to-trailing earnings;
- Price-to-forward earnings;
- Price to book;
- Price-to-trailing cash flow
The qualifying companies have a market float greater than $330-million, and value of shares traded last month over $3.8-million. They have positive estimate revisions, long-term debt to equity less than 0.91, cash flow to debt versus the industry median of over 0.75, industry-relative debt to equity levels lower than 3.35 and interest coverage over 1.5 (earnings relative to interest expense).
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 back-test the strategy from December, 1991, to November, 2016. During this process, 15 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 30 per cent of the ranked universe, or if the estimate revisions fell below negative 10 per cent.
Over this period, the strategy produced an annualized total return of 15.9 per cent while the S&P/TSX composite total return index produced 8.5 per cent. The top 15 stocks that qualify today are listed in the table below.
A noteworthy stock from our qualifying list is TFI International Inc., known until recently as TransForce Inc. In addition to the metrics shown, the transportation and logistics services provider registered an impressive one-year stock price increase of 47.1 per cent and total return of 49.2 per cent over the same period. The company also exhibits robust fundamentals, such as five-year normalized earnings growth of 10.6 per cent, five-year normalized dividend growth of 10.6 per cent, and a 16.2-per-cent forward return on equity. Following a strong quarterly earnings report, we saw a 19-per-cent increase in median analyst EPS estimates for next quarter and also for fiscal 2017.
As always, investors are encouraged to conduct their own research before purchasing any of the investments listed here.
Julie Michaels, MBA, is a relationship manager for CPMS at Morningstar Research Inc.