What are we looking for?
Companies trading below historical and sector valuations but showing positive short-term growth.
The screen
Kristine Owram of Bloomberg News interviewed key strategists in Canada who have opposing views on valuations in Canada. With this in mind, I have used Morningstar CPMS to look for companies in Canada that are still trading below their sector median and 10-year historical median valuation metrics, while showing positive short-term growth in earnings and positive analyst sentiment. The strategy ranks stocks on the best combination of:
- Quarterly earnings momentum (the past four quarters or reported earnings, compared with the same number a quarter ago);
- Three-month EPS estimate revisions (today’s median consensus estimate for earnings per share, compared with the same figure three months ago).
To qualify, stocks must be trading near or below their sector median and historical median price-to-earnings, price-to-sales and price-to-book valuation ratios. (Note that in the table, a figure of 1.0 would imply that the stock is trading at the sector median valuation or historical median valuation; a figure of 0.9 would imply that the stock is trading at a discount to the sector median or historical median.) In addition, only stocks with a market cap of $350-million were considered (this figure represents the median of the CPMS database today, which consists of 720 companies).
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 March, 2017. During this process, a maximum of 10 stocks were purchased. Stocks are sold if their rank fell below the top 40 per cent of the universe or if consensus estimate for EPS dropped by more than 10 per cent over the trailing three months (indicated in the table by "3M EPS Estimate Revision"). 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 15.2 per cent while the S&P/TSX total return index advanced 8.6 per cent. Stocks that qualify for purchase into the strategy today 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.