What are we looking for?
Stable stocks with positive estimates revisions and earnings surprises.
The screen
The decision to invest in equities is not clear-cut in our current environment.
Valuation indicators are reading the S&P/TSX composite index as being overvalued, a case in which a sell-off or correction may be imminent. However, despite the same concern of stock-market overvaluation last year, equities have continued to climb, with the S&P/TSX reaching an all-time high just last month. There are valid arguments on both sides of the table. For those who do decide to invest, choosing the right stocks becomes an ever more important undertaking.
Today, we try to construct a diversified portfolio of stocks with positive earnings estimates revisions, positive earnings surprises and low volatility. We looked for stocks with the best combination of:
Estimate revision of current-year consensus earnings per share (the difference between current median consensus EPS estimate with the same figure three months ago);
Quarterly earnings surprise (a proprietary measure of the difference between actual and expected earnings for the latest reported quarter);
Price volatility (this measures the standard deviation of daily returns over the past year; a lower value indicates stocks with lower volatility).
Stocks are only purchased in the strategy if they have a market cap of at least $400-million to ensure they are not smaller-cap stocks, which pose higher risk and are more susceptible to volatile price swings. Stocks must also have a positive quarterly earnings surprise and positive earnings-per-share revisions. Finally, stocks must also have price volatility value of 50 per cent or less.
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.
What we found
I used CPMS to back-test the strategy from December, 1999, to February, 2017. During this process, a maximum of 15 stocks were purchased and equally weighted with a maximum of four stocks a sector.
Stocks would be sold if they fell outside the top 50 per cent of the ranked universe, if their quarterly earnings surprise fell below minus 10 per cent or if their earnings-per-share revisions fell below minus 10 per cent.
Over this period, the strategy produced an annualized total return of 16.6 per cent while the S&P/TSX composite total return index advanced 6.1 per cent. Today, 14 stocks qualify for purchase into the strategy and 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.
Michael Pe, CFA, is an institutional product specialist for CPMS at Morningstar Research Inc.