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What are we looking for?

Steady growth stocks in the U.S. markets.

The screen

U.S. Federal Reserve chair Janet Yellen's recent commentary on potential "gradual increases in federal fund rates over time," reminds equity investors that a positive economic outlook often spurs investment in growth companies (defined by both current profitability and the rate of growth in earnings).

To look for these companies, I used Morningstar CPMS to create a strategy that ranks stocks on the following factors:

  • Earnings deviation (a volatility measure showing how consistent a company’s reported earnings per share have been over the past five years – lower figures preferred);
  • Three-year and five-year growth rate of earnings;
  • Quarterly earnings momentum (latest four quarters of earnings compared against the same figure one quarter ago);
  • Latest reported and forward-looking return on equity.

To qualify, companies must have at least three active analysts covering the stock, and a debt-to-equity ratio lower than that of the sector median to avoid overly leveraged companies. Limited partnerships were purposely excluded in this analysis for tax reasons.

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, 1996, to June, 2017. During this process, a maximum of 15 stocks were purchased with a maximum of four per economic sector to ensure reasonable diversification. Stocks were sold if their rank fell below the top 15 per cent of the universe, or if the company's earnings turned 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 14.5 per cent while the S&P 500 total return index advanced 8 per cent. Stocks that currently qualify for purchase into the strategy 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. stocks showing solid profitability

RankCompanyTickerMorningstar SectorMarket Cap ($Mil U.S.)Earnings Deviation5Yr EPS Growth Rate (%)3Yr EPS Growth Rate (%)Quarterly Earnings Momentum (%)Trailing ROE (%)Forward ROE (%)D/E Rel. to Sector Median *Dividend Yield (%)
1NutriSystem Inc.NTRI-QCons. Cyclical 1,571.4 14.264.345.79.348.654.10.01.3
2Trex Company Inc.TREX-NBasic Materials 2,009.6 12.838.238.36.763.551.90.00.0
3Sherwin-Williams Co.SHW-NBasic Materials 32,899.4 4.119.719.23.777.569.40.81.0
4TJX Companies Inc.TJX-NCons. Cyclical 44,128.7
5Lam Research Corp.LRCX-QTechnology 24,796.9 10.342.823.823.022.626.90.91.2
6Manhattan Assoc Inc.MANH-QTechnology 3,228.5 4.430.425.1-0.671.583.10.00.0
7Ross Stores Inc.ROST-QCons. Cyclical 21,148.2
8Paychex Inc.PAYX-QIndustrials 20,333.5 2.28.710.32.342.644.20.03.3
9Toro Co.TTC-NIndustrials 7,643.7 4.117.317.56.443.647.80.81.0
10Church & Dwight Co.CHD-NCons. Defensive 13,006.1
11PetMed Express Inc.PETS-QCons. Defensive 809.7
12Lear Corp.LEA-NCons. Cyclical 10,195.5 9.532.833.
13Electronic Arts Inc.EA-QTechnology 33,613.3 13.353.620.29.333.532.00.90.0
14McCormick & Co.MKC-NCons. Defensive 11,992.5
15Henry Schein Inc.HSIC-QHealthcare 14,333.3 1.510.710.45.319.620.80.50.0

Source: Morningstar Canada

*Here, an industry relative D/E ratio of 0.8, for example, indicates that the company has a D/E ratio 20% lower than the sector to which it belongs.