Photo illustration by the Globe and Mail
We’re pleased to toast the New Year with our Megastar ranking of Canada’s largest publicly traded companies. It contains key investing data on 250 major stocks, with a star rating for each company’s momentum appeal and another for its value merit. Both are combined to form the Megastar portfolio, which outperformed the market by 9.4 percentage points since last year. Cheers!
Our star system combines two branches of investing that have pedigrees stretching back decades – and even centuries. It starts with momentum, which favours stocks that have been winners in recent times with the hope they’ll continue to climb. Momentum is complemented with value investing principles, which seek out bargain companies trading at low prices relative to their fundamentals. Ideally, the combination of momentum and value favours bargain stocks on the mend.
Our rankings are based only on the numbers, and the tally of stars a stock gets does not reflect the character of the company, its management or its employees. Simply put, our opinions or intuitions about a company don’t enter into it. As a result, the stock of a meritorious business might get a low number of value stars if it trades at a very high price.
We believe our star system offers an objective take on the largest 250 common stocks on the TSX with at least 12 months of trading history. We also try to skip over firms that are in the process of being purchased by another company, such as the recently announced takeover of Logistec Corp., because they are better addressed by merger specialists.
We hope you enjoy the team of Megastars for 2024 and you can learn more about the top stocks and our star system below.
The great wave
Momentum investors seek stocks on the upswing because they tend to continue to climb in the short term. The key being to jump quickly from one hot streak to the next. On the other hand, stocks on the decline tend to continue to lag the market while they try to turn their fortunes around.
Buying based on momentum may seem to be too simple to work, but it has a long and profitable track record that goes back decades in many markets.
We take a balanced approach to momentum and merge results from three different time periods. Stocks get more stars when they’ve outperformed their peers over the past three, six and 12 months.
In addition, we favour steady returns and try to avoid the most highly-volatile stocks. The goal is to sidestep stocks that might fail to compensate investors for the risks they involve.
We combine the momentum measures to arrive at the momentum star rating for each stock, and the top 10 per cent (or 25 stocks) get a full five out of five stars.
In back tests, the five-star momentum portfolio gained an average of 14.4 per cent annually from the end of 1999 through to the end of November, 2023, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. In comparison, the S&P/TSX Composite Index (a reasonable proxy for the Canadian stock market) gained an average of 6.5 per cent a year over the same period. (Our data comes from Bloomberg. All of the returns herein include dividend reinvestment, but not fund fees, taxes, inflation, commissions and other trading costs.)
Momentum stocks often fare well with short holding periods and the five-star momentum portfolio is no exception. Slow down its rebalancing period to once a year, and its gains fall to an average of 11.2 per cent annually from the end of 1999 to the end of 2022. Mind you, the portfolio handily outperformed the market index, which climbed by an average of 6.4 per cent a year.
Bargain hunting
Value investors hunt for bargains using a variety of metrics. Our analysis starts by seeking stocks selling at low prices relative to their net worth. That’s why we favour companies with low price-to-book-value ratios (P/B).
The ratio compares a firm’s market value to the amount of money that could be theoretically raised by selling its assets at their balance-sheet values and paying its debts. A low P/B indicates you’re likely buying a company at a discount – or at least for a reasonable price.
Assets are one thing, but profits represent the beating heart of an enterprise. That’s why we reward profitable companies that trade at relatively low price-to-earnings ratios (P/E). The ratio is a staple for value investors, which has worked well for decades.
We also desire companies that use their capital wisely, which leads to a stock’s return on equity (ROE). ROE is a common measure of business quality and it indicates how much a firm is earning compared with the amount its shareholders have invested.
Finally, we appreciate companies that have enough money to buy back their own shares. We particularly like those that have reduced their share counts significantly over the past four quarters. After all, a well-executed repurchase program can provide a big boost to shareholders when companies trade at bargain prices and have cash to spare.
Value stars are awarded by combining all of the value factors, with the top 10 per cent (or 25 stocks) getting a full five out of five stars.
The five-star value portfolio gained an average of 15.2 per cent annually from the end of 1999 through to the end of November, 2023, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. In comparison, the market index gained an average of 6.5 per cent annually over the same period in the back test.
Value stocks can usually be held for months, and often years, with good success. The approach’s longer-term nature can be seen when the portfolio is rebalanced annually, which resulted in average annual gains of 15.3 per cent from the end of 1999 to the end of 2022. The market index climbed by an average of 6.4 per cent a year over the same period.
The Megastar team
We marry momentum and value by combining all of the factors mentioned above. Simply put, the Megastar portfolio contains the 20 stocks with the best overall rating.
We’re pleased to say the Megastar portfolio outperformed since last year. The 20-stock portfolio gained an average of 13.3 per cent from December 1, 2022, to December 20, 2023, assuming an equal amount of money was invested in each stock without rebalancing. By way of comparison, the market index trailed with a gain of 3.9 per cent over the same period.
The Megastars’ track record can be extended using back tests. The 20-stock portfolio provided average annual returns of 13.9 per cent from the end of 1999 to the end of November, 2023, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. It gained an average of 12.9 per cent from the end of 1999 to the end of 2022 when rebalanced annually.
In addition, the Megastar portfolio was roughly one-fifth less volatile, on average, than either the five-star momentum or five-star value portfolios in the monthly back tests. Over all, we believe most investors benefit by exchanging slightly lower expected returns for much lower volatility. With a little luck, the Megastar team will continue to deliver strong results while allowing investors to nap worry-free.
Meet the Megastars: The best 20 TSX stocks for a blend of value and momentum
Great expectations
The Megastars and our star rankings represent a great starting point for further research, but you should improve your understanding of each company by studying it and its industry in detail before investing.
Be aware of the limitations of numerical methods such as ours, because other factors can be important when investing. For instance, the quality of a company’s people can sometimes help – or hinder – a business.
Similarly, unexpected events from the political and global to the local can sideswipe the market and individual companies. That’s why investing in stocks can be risky. But it’s nearly impossible to avoid the vicissitudes of fate and still earn a decent return.
We also hope our portfolios achieve similar returns to those achieved so far and in the back tests, but the market isn’t that predictable. Even in the best circumstances, we expect results to be bumpy and some individual stocks will disappoint. We would be pleased indeed to outperform the market index by an average of a few percentage points a year over the next couple of decades. (For the sake of disclosure, the author owns many of the stocks mentioned herein.)
Watch your step with stocks that trade infrequently, and those with very low share prices, because they may be difficult to buy or sell in a timely and cost-effective manner.
But enjoy looking up the facts and figures that mean the most to you. After all, the purpose of our star system is to help you narrow in on companies you might want to add to your portfolio.
Norman Rothery