What are we looking for?
Companies that rallied in 2016, but trading at reasonable valuations relative to their own history.
The screen
In the 2016 calendar year, we saw almost all sectors within the S&P/TSX composite (with the exception of health care) post strong returns. Does this leave any room for value-oriented investors in 2017? To answer this question, I created a strategy that ranks stocks on their price changes over various periods, while simultaneously filtering for companies that are trading near or below their 10-year historical median price-to-book, price-to-cash-flow, price-to-sales and price-to-earnings ratios. Specifically, the cut off used here is 1.1 times (meaning that the company is trading within a 10-per-cent premium or lower to their 10-year historical valuation ratios).
To qualify, stocks must have an average monthly value of shares traded of $2-million or greater (this figure represents the top two thirds of companies in the Morningstar CPMS Canadian database, which today consists of roughly 720 names).
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 backtest this strategy from December, 1991, to December, 2016. During this process, a maximum of 20 stocks were purchased with a maximum of five stocks per economic sector. Stocks are sold if their rank falls below the top 40 per cent of the universe, or if the stock's historical valuations (measured by the same metrics listed above) exceed 1.3 times (in other words, if their valuations exceed 30 per cent of the stock's own 10-year historical median valuation). Over this period, the strategy produced an annualized total return of 21.4 per cent while the S&P/TSX composite total return index advanced 8.6 per cent.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.