What are we looking for?
Value, Canadian-style. We want to find stocks that appear cheap by several standard measurements.
How we did it
Craig McGee, senior consultant at Morningstar Canada, scoured the CPMS Canadian database for companies that are trading for low multiples of their earnings. He wanted to find stocks with price-to-earnings (P/E) ratios that are lower than the market average, based both on the profits they've already reported as well as the earnings that analysts expect them to report in the future.
In addition, he wanted to turn up stocks that are cheap in comparison to their cash flow and in terms of their book value. He also looked for companies for which analysts have raised their earnings estimates.
To ensure adequate diversification, he allowed no more than five stocks per sector in the portfolio.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment 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.
What we found
The CPMS Canadian Value strategy has enjoyed an outstanding few months. Year-to-date, it's up 10.9 per cent while the TSX Composite Total Return Index is up only 6.7 per cent. Going back to Dec. 31, 1985, the strategy has generated an annualized return of 15.3 per cent vs. 8.1 per cent for the index.
That's a huge degree of outperformance considering that there's nothing particularly revolutionary about the approach. All the yardsticks it uses to measure value are popular, long-time favourites of value hunters. It appears that bargains sometimes do hide in plain sight – at least for patient investors.