What are we looking for?
Canadian companies that exhibit both safety and value.
As the S&P/TSX composite index exhibited losses late last week and early this week, skittish investors watching the market closely may be looking to adjust their holdings, though the verdict is out on whether a larger correction is in the cards in Canada. Although nowhere near as frothy as the U.S. markets, Canadian markets have still shown positive gains in the trailing five-year period and value-oriented investors may find it a bit tougher to find reasonable names today in Canada. All the above considered, today's strategy ranks stocks based on the following factors:
- Five-year price beta (recall that beta measures a stock’s historical sensitivity to an index. Stocks with beta less than one tend to move less than the index in trending markets. As a defensive measure, today we prefer companies with lower beta);
- Standard deviation earnings over the past five years (another safety metric which looks at how consistent a company’s reported earnings have been over the past five years, lower numbers referred);
- Price-to-book value;
- Forward price-to-earnings.
To qualify, companies must have a market cap greater than $490-million (this figure represents the median market cap in the CPMS Canadian database, which today consists of roughly 700 companies). In addition, companies must have a debt-to-equity ratio that is in line with or lower than that of the sector to which it belongs. (A figure of 0.9 for example, would imply that the company has a D/E ratio that is 10-per-cent lower than the median of the sector.)
Companies must also pay a dividend of some sort.
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 May, 1992, to January, 2018. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four stocks per economic sector. Stocks would be sold if their rank fell below the top 35 per cent of the ranked universe. 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 13.8 per cent while the S&P/TSX composite total return index advanced 8.8 per cent. In addition, there were 32 of 102 quarters over this time period where the S&P/TSX composite total return index showed negative returns. Of these 32 quarters, the above strategy outperformed the index 88 per cent of the time, which speaks to the defensive nature of the strategy.
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 buying or selling any of the investments listed here.