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What are we looking for?

U.S. stocks showing top- and bottom-line growth, sitting outside of the S&P 500 index.

The screen

In last week's Number Cruncher, I explored companies in the United States paying dividends backed by consistent earnings with the idea that Canadians looking to access U.S. equities might see relative weakness in the U.S. dollar – at least compared with the latter portion of 2015 – as an opportunity to take advantage of the foreign exchange rate.

Keeping with this theme, this week I created a strategy that again looks at consistent earnings, but focuses on lesser known companies outside the S&P 500 that show positive top line (sales) and bottom line (earnings) growth. The strategy ranks stocks on best combination of:

  • Earnings consistency (measured by the standard deviation of reported earnings per share over five years – here, lower numbers are preferred);
  • Five-year sales growth rate (how much top-line revenue has grown over five years);
  • Five-year EPS rate (how much earnings has grown over five years);
  • Estimate predictability (that is, the consistency of a company’s estimated earnings from analysts, calculated as the “coefficient of variation” on current fiscal EPS estimates – lower scores preferred).

To qualify, companies must have a cash-flow-to-debt ratio greater than 0.3 (the median in the CPMS U.S. database), at least five analysts covering the stock and they must show positive analyst-estimate changes over the past three months. In addition, members of the S&P 500 were excluded .

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 April, 2016. During this process, 10 stocks were purchased and equally weighted with a maximum of three stocks a sector. Stocks would be sold if they fell outside the top 30 per cent of the ranked universe, or if estimate revisions fell by more than 10 per cent over a three-month period.

Over this time frame, the strategy produced an annualized total return of 14.2 per cent while the S&P 500 total return index produced 7.5 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.

U.S. growers outside the S&P 500

RankCompanyTickerMarket Cap (US$-mil)5Y EPS Growth Rate (%)5Y Sales Growth Rate (%)Earnings ConsistencyEstimate PredictabilityCash flow to Debt Ratio3 Month EPS Estimate Revision (%)Dividend Yield (%)
1LKQ Corp.LKQ-Q10,104.720.1725.133.301.220.3810.370
2Wabtec Corp.WAB-N7,365.523.7115.692.731.630.671.720.40
3Cooper Companies Inc.COO-N7,551.915.127.992.640.850.335.210.04
4Texas Roadhouse, Inc.TXRH-Q3,162.410.8113.882.522.077.741.171.68
5Polaris Industries Inc.PII-N5,753.222.9520.025.301.951.261.092.48
6Trex Company Inc.TREX-N1,313.997.9410.3720.903.30n/c0.740
7East West Bancorp Inc.EWBC-Q5,270.315.883.423.000.760.442.132.18
8Dril-Quip Inc.DRQ-N2,271.922.2012.949.322.60n/c0.790
9A.O. Smith Corp.AOS-N6,918.630.848.787.851.531.480.711.22
10PrivateBancorp Inc.PVTB-Q3,225.470.770.368.781.760.342.400.10

Source: Morningstar Canada

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