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What are we looking for?

Income from the S&P 500.

The screen

With all eyes on the U.S. presidential election, nervous investors may look to err on the side of caution with their U.S. equity exposure. With this in mind, this week I revisit the CPMS U.S. large-cap income model, which is a conservative strategy looking for sustainable yields and low volatility. The strategy ranks stocks based on the following factors:

  • Forward return on equity;
  • Return on total assets;
  • Market cap (larger companies are preferred here);
  • Three-month EPS estimate revisions;
  • Dividend yield relative to the sector median (for example, Philip Morris’s relative yield of 2.17 per cent means that the stock is paying 2.17-per-cent higher than the median stock in the sector).

To qualify, stocks must have a market cap greater than $17-billion (U.S.) and a yield greater than 2.3 per cent (these figures represent the median values in the S&P 500 today).

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 August, 1998, to September, 2016. During this process, a maximum of 20 stocks were purchased and equally weighted with a maximum of five stocks a sector. Stocks would be sold if they fell outside the top 30 per cent of the ranked universe, or if the dividend payout ratio on earnings exceeded 100 per cent (signifying the company is paying out more in dividends than it is making in profit).

Over this period, the strategy produced an annualized total return of 9.2 per cent while the S&P 500 total return index advanced 6.6 per cent. The top 20 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.

U.S. large caps with low volatility

RankCompanySymbolMorningstar SectorMarket Cap ($Mil U.S.)Yield Rel. to Sector Median (%)Fwd Rtn on Equity (%)Rtn on Total Assets (%)3M Est. RevisionYield (%)Payout Ratio on EPS (%)
1Philip Morris Intl Inc.PM-NConsumer Defensive149,827.22.1749,850.0022.22-0.304.3183.45
2Altria Group Inc.MO-NConsumer Defensive126,433.91.63336.0120.900.453.7772.84
3AbbVie Inc.ABBV-NHealthcare100,236.83.16244.4913.760.893.7040.14
4McDonald's Corp.MCD-NConsumer Cyclical96,191.01.55452.9415.860.823.3461.04
5Merck & Co Inc.MRK-NHealthcare171,304.72.4224.2511.124.722.9747.42
6United Parcel ServiceUPS-NIndustrials94,690.60.91278.8514.12-1.522.8950.61
7Amgen Inc.AMGN-QHealthcare118,162.51.9931.1212.122.302.5332.76
8Intel Corp.INTC-QTechnology166,058.11.5820.8812.053.702.9637.14
9Pfizer Inc.PFE-NHealthcare195,799.33.1726.589.490.383.7244.94
10Johnson & JohnsonJNJ-NHealthcare311,780.52.2626.1413.920.072.8145.01
11PepsiCo Inc.PEP-NConsumer Defensive153,787.50.6759.1410.050.392.8158.11
12L Brands, Inc.LB-NConsumer Cyclical20,795.91.5140,500.0015.362.403.3059.26
13Microsoft Corp.MSFT-QTechnology475,265.51.1830.6511.690.522.5653.79
143M CompanyMMM-NIndustrials100,469.50.6942.2315.91-0.572.6750.74
15Yum! Brands Inc.YUM-NConsumer Cyclical31,463.40.5942,000.0014.780.002.3848.57
16Cisco Systems Inc.CSCO-QTechnology152,135.52.0520.5910.54-0.583.4340.78
17AT&T Inc.T-NCommunication Services225,778.43.4615.334.61-0.335.3465.12
18HP Inc.HPQ-NTechnology23,781.22.1916,100.0010.12-1.233.5730.81
19Hershey Co.HSY-NConsumer Defensive20,425.70.44162.6917.43-0.872.5854.21
20Lockheed Martin Corp.LMT-NIndustrials75,502.30.9475.747.36-3.922.9259.43

Source: Morningstar Canada