What are we looking for?
Long-term capital appreciation with emphasis on income generation.
The screen
Taking a closer look at the type of stocks that have been driving the market rally this past year, we see unmistakable domination from the oil and gas sector and metals and minerals, specifically golds. These stocks exhibit strong momentum attributes, especially price momentum, but are lacking in income and growth characteristics. For the investors who do not want to jump on the volatile momentum bandwagon, I have analyzed a more conservative fundamental approach to stock selection by focusing on growth and income.
I used CPMS to build a strategy that ranks stocks based on the best combination of:
- Five-year normalized earnings growth (annual compound growth of earnings per share averaged over the past five years);
- Five-year normalized sales growth (annual compound growth of sales averaged over the past five years);
- Three-month analyst estimate revisions (current consensus estimate for earnings per share versus three months ago);
- Quarterly earnings momentum (rate of change of quarterly operating earnings per share);
- Expected dividend yield;
- Quarterly earnings surprise (proprietary measure of the percentage difference between actual and expected earnings);
- Trailing return on equity.
To ensure sufficient liquidity, qualifying companies have a market float greater than $500-million, and average monthly value traded of more than $3.5-million. They have a yield higher than 1.75 per cent, earnings revisions greater than negative 5 per cent and a quarterly earnings surprise greater than negative 10 per cent.
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 August, 2016. During this process, 20 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 40 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 15.1 per cent while the S&P/TSX composite total return index advanced 9 per cent. Twelve stocks that qualify today are listed in the accompanying table.
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.