What are we looking for?
Canadian companies reinvesting for future growth.
The screen
There are multiple schools of thought on what a company should do with their bottom line. One of these options is to distribute profits to shareholders via dividends, which is a style that is heavily in favour for Canadian investors. Companies can also opt to reinvest these proceeds for future growth of the company. For investors with a longer time horizon who are able to take on more risk in exchange for future returns, the reinvestment option can be a viable strategy. This week's screen may offer some food for thought in the latter arena. To do this, I used Morningstar CPMS to rank the largest 250 companies in Canada (excluding real estate investment trusts) on the following metrics:
- Forward and trailing reinvestment rates (estimated or trailing earnings per share less dividends per share as a percentage of the company’s book value per share – higher figures preferred);
- Three-month estimate revision (today’s consensus estimate for EPS for the stock compared against the same figure at month end, three months ago);
- Quarterly sales momentum (trailing four quarters of reported sales, compared with the same figure one quarter ago);
- Latest earnings surprise (the latest reported figure for EPS compared with the estimate just prior to the company reporting).
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 December, 1991, to October, 2017. During this process, a maximum of 20 stocks were purchased with a maximum of five per economic sector to ensure reasonable diversification. Stocks would be sold if their rank fell below the top 40 per cent of the universe, if the company missed earnings expectations, or if estimates dropped by more than 10 per cent. 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 15.8 per cent while the S&P/TSX composite total return index advanced 8.6 per cent. The stocks that meet our requirements for purchase are listed in the accompanying table.
As always, it is recommended that investors 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.