What are we looking for?
Value picks with low price-to-book ratios in the Canadian energy sector.
The screen
Investors who feel that the price of crude oil is poised to show an upward trend will find this read an interesting one.
In this week's screen, I focus on the price-to-book ratio of energy stocks in Canada. Remember that the book value measures the theoretical value of a company's equity should the company be liquidated. The price-to-book ratio is a value metric that investors can use to show whether a company is over- or undervalued relative to peers. (The lower the number, the better.)
It is interesting to note that if we look at the median price-to-book value of Canadian energy stocks today (0.8), it is very close to post-2008 levels (0.83) when crude oil also saw a large drop in price. So, if you are of the mindset that oil will begin to trend upward relatively soon, this screen may provide some reasonable ideas in the Canadian energy space. This week, I used CPMS to look for energy companies in Canada with the best possible combination of the following factors:
– price to book;
– industry relative price to book (the relationship between a company's price-to-book ratio and the price-to-book ratio of the industry group);
– quarterly earnings momentum (the latest four quarters of earnings, compared with the same number one quarter ago);
– market cap (larger market cap companies were favoured);
Only companies in the energy sector were considered.
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. 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 this strategy from December, 1991, to January, 2015. During this process, 10 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 20 per cent of the database. Over this 24-year period, the strategy produced an annualized return of 11.4 per cent while the S&P/TSX composite total return index returned 8.9 per cent. During this time, only stocks in the energy sector were held.
It is worthwhile to note that from 2000 to 2005 (when the price of oil trended upward), the strategy significantly outperformed the benchmark each year. As expected, in 2014 when the market saw a steep drop in oil prices, the strategy underperformed the benchmark by by 16.1 percentage points.
Investors are always advised to conduct independent research before purchasing stocks listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.