Craig McGee is a senior consultant at Morningstar Canada.
What are we looking for?
Despite the market's weakness in recent months, most sectors have been experiencing steadily growing earnings. To help take advantage of a potential bounce-back, I wanted to look for large and liquid Canadian stocks with strong profitability and momentum.
I searched the CPMS Canadian equity database for the 20 stocks with the best combination of the following metrics:
– Return on equity;
– Revision of the consensus earnings-per-share estimate over the past three months;
– Latest earnings surprise (the percentage difference between the firms' quarterly operating earnings and the consensus estimate for that quarter);
– Price momentum over the past three and nine months, as well as 12 months (where stocks closer to their 12-month high are favoured).
Selections had to be in the top third of the database based on average monthly value traded, and the one-month price change could not be negative. No more than five stocks per sector were allowed.
More about Morningstar
Morningstar 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
Using CPMS, I back-tested the strategy to apply the same rules-based approach starting Dec. 31, 1985. A portfolio of up to 20 stocks was equally weighted and stocks would be replaced if their rank fell outside of the top 40 per cent of the subset database.
Over the 12 months ended Sept. 30, 2014, the strategy generated a total return of 21.1 per cent versus 20.4 per cent for the S&P/TSX Total Return Index. Since inception on Dec. 31, 1985, following this strategy with a strict discipline would have generated an annualized total return of 18.4 per cent while the index came in at 8.6 per cent.
Investors are advised to do their own research before investing in any of the stocks shown here.