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What are we looking for?

Slow-moving stocks yielding higher than the sector median.

The screen

This week, I used Morningstar CPMS to create a strategy for conservative investors who would rather receive income over price appreciation of the stock value. The strategy ranks stocks based on the following factors:

  • Three-year and five-year historical price beta (recall that beta measures the sensitivity of a company to the movement of the benchmark – here, we use the S&P/TSX composite total return index. In trending markets, a stock with beta of less than one has historically moved less than the benchmark index – in today’s strategy, we prefer low beta);
  • Six-month and one-year standard deviation of returns (also a volatility metric, standard deviation measures the distribution of returns over trailing periods. In our strategy we prefer a tighter distribution, indicating the stock price does not fluctuate drastically);
  • Dividend yield relative to the industry median.

To ensure that our dividend-paying companies maintain their yield, I require their payout ratio on earnings be less than 80 per cent and the payout ratio on cash flows be less than 60 per cent. Lastly, companies with market cap less than $125-million were excluded in this analysis (this figure represents the bottom third of stocks by market cap in the CPMS Canadian Database, which today consists of 717 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 January, 1999, to April, 2017. During this process, a maximum of 20 stocks were purchased with a maximum of five per economic sector to ensure reasonable diversification. Stocks are sold if their rank falls below the top 30 per cent of the universe, or if the company's payout ratios exceed 100 per cent on earnings or 80 per cent on cash flows. 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 12.6 per cent while the S&P/TSX composite total return index advanced 7.3 per cent. The 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.

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