What are we looking for?
Canadian companies with rising profits. History shows that companies with "earnings momentum" often continue to enjoy bottom-line gains.
How did we do it?
Craig McGee, senior consultant at CPMS Morningstar Canada, led us through the strategy that shapes his firm's Canadian Earnings Momentum portfolio.
The strategy searches among the largest 250 Canadian stocks for companies with quarterly earnings momentum and large, positive revisions to analysts' earnings estimates. It narrows down the candidates by looking for companies with strong gains in stock prices over the past nine and 12 months, as well as positive earnings surprises.
Quarterly earnings momentum measures the rate of change of quarterly operating earnings per share (excluding unusual gains or losses). It is calculated as the percentage change between the latest year of operating earnings per share and the equivalent figure from the previous quarter.
The portfolio is made up of 20 stocks. Each is held until it falls out of the top 30 per cent of all ranked stocks. It then gets replaced by the best ranked stock available.
To make sure the portfolio is diversified, the strategy allows no more than five stocks from any one industry group.
More about Morningstar
Morningstar 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.
What we found
The CPMS model has generated a total return of 18.4 per cent so far this year, outpacing the 3.9-per-cent gain from the S&P/TSX Composite Total Return Index over the same period.
Since Dec. 31, 1985, the model has generated an annualized return of 21.5 per cent. Remember, though, that these returns don't include trading costs. And keep in mind that strategies that worked in the past aren't guaranteed to produce similar results in future.