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number cruncher

What are we looking for?

U.S.-listed companies with consistent earnings and dividends outside of the S&P 500 index.

The screen

Canadian investors are often susceptible to home-country bias. That is, we often look to invest in companies within our borders that we can recognize. This leads to two problems: one, the lack of diversification should Canada's economy take a turn for the worse; and two, lost opportunity in sectors that are under-represented in Canada. The U.S. equity markets are accessible to most Canadian investors, yet many investors are skittish in investing in companies with a lack of brand recognition. This week, I bring some of these companies to light by looking for stocks outside of the S&P 500 index and ranking them by:

  • Five-year earnings-per-share variability (a measure of how consistent a company’s earnings are when compared against the five-year median EPS – lower numbers indicate more consistent earnings reports);
  • Dividend yield;
  • Five-year historical beta (recall that stocks with lower beta are historically less sensitive to general market movements than high-beta stocks).

To qualify, stocks must have a daily dollar trading volume of $27-million (U.S.) or above, a cash-flow-to-debt (CF/D) ratio greater than 0.3 and a debt-to-equity (D/E) ratio of less than 0.7 to avoid overly leveraged companies. (The figures 0.3 and 0.7 represent the median CF/D and D/E, respectively, of all stocks in the CPMS U.S. database today). Lastly, stocks must have a dividend payout ratio of less than 80 per cent to ensure sustainable yields over time.

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 CPMS to back-test the strategy from April, 2004, to February, 2016. During this process, 20 stocks were purchased and equally weighted with a maximum of five stocks a sector. Stocks would be sold if they fell outside the top 30 per cent of the ranked universe, or if the payout ratio breached 100 per cent. Over this period, the strategy produced an annualized total return of 10.4 per cent while the S&P 500 total return index advanced 7 per cent. Today, 15 stocks qualify for purchase into the strategy and are listed in the accompanying 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.

U.S. stocks outside the S&P 500

RankCompanyTickerVariability around 5Y EPS (%)Dividend Yield (%)5Y BetaCash flow to Debt RatioDebt to Equity RatioTrailing Payout Ratio (%)Daily Average Dollar Trading Volume ($US-mil)
1Cullen/Frost BankersCFR-N2.963.851.121.730.0849.0771.08
2Williams-Sonoma Inc.WSM-N2.112.721.09N/A041.0581.22
3Wadell & Reed Fin.WDR-N10.547.961.791.480.2255.1339.93
4Maxim Integrated Prod.MXIM-Q4.163.320.960.590.4775.4493.87
5Novartis AGNVS-N5.963.80.60.770.2157.21173.86
6Prosperity BancsharesPB-N3.562.621.370.710.1427.4129.78
7Hubbell Inc.HUBB-N3.992.431.130.60.3441.8636.64
8FNB Corp.FNB-N5.973.671.070.360.3154.5528.37
9Polaris Industries Inc.PII-N3.852.231.321.260.4731.41137.12
10Arthur J. Gallagher & Co.AJG-N5.313.431.070.310.5658.2648.66
11Noble Corp. PLCNE-N21.775.691.930.390.5649.04109.36
12DSW Inc.DSW-N8.212.860.78N/A052.2951.3
13ResMed Inc.RMD-N5.942.130.641.110.2644.6268.25
14MSC Industrial DirectMSM-N7.512.290.741.650.1543.6452.46
15Watsco Inc.WSO-N7.082.521.

Source: Morningstar Canada