What are we looking for
Sin stocks with growing earnings in the U.S. market.
U.S. President Donald Trump certainly isn't shy in his intentions with responses to countries such as North Korea building up their weapons arsenal. Keeping with this theme, this week I used Morningstar CPMS to create a strategy that looks at what investors deem as "sin" stocks, which include such industries as weapons and aerospace, alcohol, tobacco, and gambling. The strategy ranks stocks from these sectors based on the following factors:
- Quarterly earnings momentum (the latest four quarters of earnings compared against the same figure one quarter ago);
- Five-year earnings per share growth rate (this looks at how much on average a company has grown its earnings per year over the past five years);
- PEG ratio (a GARP measure that compares the price to earnings ratio with the expected growth rate of earnings, lower figures preferred);
- Trailing return on equity;
- Return on total assets.
Only stocks in the aforementioned industries were considered in this analysis. To qualify, stocks must show a positive figure in their latest reported EPS figure.
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 December, 1993, to July, 2017. During this process, a maximum of 15 stocks were purchased and equally weighted. Stocks are sold if their rank falls below the top 25 per cent of the CPMS U.S. database (which today consists of 2,200 companies) based on the three factors mentioned above, or if earnings turn negative. 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 16.2 per cent while the S&P 500 industrials total return index produced 9.8 per cent. Stocks that qualify for purchase into the strategy today are listed in the table.
As always, investors are encouraged to 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.