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What are we looking for?
Companies that conservative Canadian investors should shy away from.
For many years, Morningstar CPMS has tracked a Canadian "Dangerous" portfolio that looks for companies with undesirable fundamental characteristics. The strategy itself is designed to underperform the market. However, it did well in 2016, which is highly uncharacteristic of the portfolio and is a hint that the market is rewarding companies with less than stellar fundamentals. Generally speaking, longer-term conservative investors will tend to stay away from stocks in this strategy. The Morningstar CPMS Dangerous Portfolio ranks stocks on the worst combination of:
- Quarterly earnings momentum (latest four quarters of reported earnings compared against the same figure one quarter ago. For the Dangerous Portfolio, low or negative values are preferred);
- Price-to-book and price-to-earnings ratios versus sector medians (here, high values are best, indicating the stock is overvalued relative to its peers);
- Three-month EPS estimate revision (latest consensus estimate of earnings per share versus the same figure three months ago, low values are preferred);
- Quarterly earnings surprise (consensus EPS estimate prior to the company reporting versus the actual reported EPS, low values preferred);
- Latest trailing cash flow to long-term debt (low values preferred);
- Long-term debt to equity (high values preferred).
To qualify, stocks must have an average monthly trading volume of roughly $13-million (the median value in the Canadian CPMS database).
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I referred to Morningstar CPMS to track the performance of this strategy from December, 1985, to December, 2016. The model holds a maximum of 30 stocks in an equally weighted portfolio. Stocks are sold if their rank falls below 150 (today there are roughly 720 companies in the Canadian CPMS Universe). Over this period, the strategy produced an annualized total return of negative 8.7 per cent while the S&P/TSX composite total return index produced 8.3 per cent. In calendar year 2016, the strategy produced a whopping (positive) 29.9 per cent, while the S&P/TSX produced 21.1 per cent. Looking back over history, the strategy consistently underperformed the S&P/TSX in each calendar year except for 1999 (pre-tech bubble), 2009 (post U.S. housing crisis), and 2016.
The top 20 stocks that qualify are in the table below. Recall that if a stock qualifies for the Dangerous strategy, conservative investors may want to avoid it. Investors are encouraged to conduct their own independent research before purchasing or selling any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
Morningstar CPMS Dangerous Portfolio
|Rank||Company||Ticker||Market Cap ($Mil)||D/E||CF/D||Latest Earns. Surprise (%)||3M EPS Estim. Rev. (%)||P/E Rel. to Sector Median||P/B Rel. to Sector Median||Qtly Earns. Mom. (%)||Avg. Monthly Trading Vol. ($ Mil.)||Div. Yield %|
|9||Black Diamond Grp||BDI-T||230.6||0.3||0.5||-6.9||-140.0||n/c||0.3||-80.1||24.7||6.1|
|11||ProMetic Life Sciences||PLI-T||1,346.6||0.3||-1.8||-2.3||0.0||n/c||3.6||-10.0||97.8||0.0|
|14||Colliers Intl Grp||CIGI-T||1,800.8||1.8||0.5||-6.9||1.6||1.0||8.0||-4.7||59.2||0.3|
|18||Just Energy Group||JE-T||1,061.2||n/c||0.7||-31.3||21.7||0.5||425.6||-20.2||51.2||7.0|
|19||Cdn Natural Resources||CNQ-T||45,593.1||0.6||0.2||-25.1||-1.0||0.5||1.5||-62.7||1,913.0||2.4|
Source: Morningstar Canada
Note 1: In the majority of the above cases, the "n/c" for P/E ratio means that the company's earnings are negative, hence a ratio is not calculable. Note 2: Both BBD.B and JE have negative equity values hence a debt/equity ratio is not calculable.