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What are we looking for?

Canada's most profitable companies outside of the S&P/TSX composite index.

The screen

Return on equity is an extremely important metric when measuring profitability of companies. ROE is typically calculated by taking the company's trailing four quarters' bottom line (net income), and dividing this by the average shareholder's equity over the same period. This ratio tells us how much profit is being made using the money invested by common shareholders. This week, I use Morningstar CPMS to look for companies that have shown their shareholders that not only are they currently profitable, but they are profitable on a reasonably consistent basis over a longer time frame.

To find lesser-known names showing the above traits, I ranked stocks outside of the S&P/TSX composite index on the following factors:

  • Latest reported ROE;
  • Quarterly ROE momentum (taking the latest ROE, and comparing it with the ROE from one quarter ago);
  • Average ROE over the past three, five and 10 years;
  • Standard deviation of ROE over the past five and 10 years (standard deviation is a measure of volatility – here we prefer less volatility or lower figures, signalling consistency of ROE over trailing periods).

To qualify, companies must have a market capitalization greater than $80-million. This figure represents the bottom third of companies in the Morningstar CPMS universe (which today consists of 720 companies). Additionally, only companies with a debt-to-equity ratio equal to or less than that of their sector median were considered to avoid companies propping up profits by issuing debt.

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 November, 2002, to May, 2017. During this process, a maximum of 15 stocks were purchased and equally weighted with a maximum of three an economic sector to ensure reasonable diversification. Stocks are sold if their rank falls below the top 25 per cent of the universe, or if the company's 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 18.3 per cent while the BMO Nesbitt Burns small-cap total return index advanced 8 per cent. Today, only 10 stocks qualify for purchase into the strategy and they 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.

Consistently profitable companies outside the S&P/TSX

RankCompanyTickerMarket Cap ($Mil)Morningstar SectorTrailing ROE (%)Qtrly ROE Momentum (%)3Yr Avg. ROE (%)5Yr Avg. ROE (%)10Yr Avg. ROE (%)5Yr Std. Devation of ROE (%)10Yr Std. Deviation of ROE (%)D/E Rel. to Sector Median*Div. Yield (%)
1Equitable Group Inc.EQB-T 1,004.2 Fin. Services17.6 4.6 17.017.217.00.51.20.51.5
2Evertz TechnologiesET-T 1,352.0 Technology20.3 25.4 19.518.127.42.415.60.14.0
3Exco Technologies Ltd.XTC-T 460.1 Cons. Cyclical17.2 1.8 17.917.311.91.06.40.23.0
4Calian Group Ltd.CGY-T 203.9 Industrials18.7 0.5 17.118.320.62.03.80.04.2
5Andrew Peller Ltd.ADW.A-T 473.2 Cons.Defensive14.5 5.3 12.912.311.01.12.20.41.6
6Leon's Furniture Ltd.LNF-T 1,277.3 Cons. Cyclical12.8 1.0 12.612.114.50.92.80.82.7
7Rogers Sugar Inc.RSI-T 617.6 Cons. Defensive16.8 3.1 13.313.715.62.03.20.75.5
8Canaccord GenuityCF-T 589.1 Fin. Services7.0 2,003.0 1.01.57.23.69.20.60.8
9Pure Technologies Ltd.PUR-T 262.9 Technology4.0 76.9 3.23.02.81.65.30.02.5
10Valener Inc.VNR-T 881.4 Utilities8.1 4.1 6.86.39.10.84.40.14.9

Source: Morningstar Canada

* Here an industry relative D/E ratio of 0.5, for example, implies the company's D/E ratio is 50% lower than that of the sector to which it belongs