What are we looking for?
Profitable Canadian companies returning capital to investors.
The screen
This week, I look for companies trading in Canada that have good long-term profitability and exhibit effective use of investors' capital (both debt and equity) and have shown short-term growth in earnings. To find these companies, I ranked stocks in the Morningstar CPMS Canadian database (today this universe consists of 710 companies) on the following factors:
- Total return on capital (a measure of the company’s profitability that relates the firm’s pretax earnings to all the capital involved in the firm, including debt, preferred and common stock);
- Quarterly earnings momentum (latest four quarters of reported earnings compared with the same figure one quarter ago);
- Five-year average return on equity (recall that return on equity is also a profitability metric, measuring the net income or “bottom line” of a company against shareholder equity).
To qualify, companies must have at least three active analysts covering the stock. Real estate investment trusts were excluded in this analysis.
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 this strategy from November, 2001, to December, 2017. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four stocks representing each economic sector. Stocks would be sold if their rank fell below the top 35 per cent of the ranked universe, or if consensus estimates on earnings dropped by more than 5 per cent over three months. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 17.2 per cent, while the S&P/TSX composite total return index advanced 7.7 per cent. In calendar year 2017, this strategy produced 18.5 per cent, while the index gained 9.1 per cent.
The stocks that meet our requirements for purchase today are listed in the accompanying table.
As always, it is recommended that investors 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.