What are we looking for?
Steady stocks growing at a reasonable price.
With the S&P/TSX Composite Index now well above its prepandemic highs, growth-hungry investors continue to be on the lookout for companies that remain somewhat reasonably priced, at least relative to their rate of growth.
Today, we use Morningstar CPMS to look for companies that exhibit those characteristics along with a history of steady earnings and profitability. To do this, I first rank the 712 companies in the Morningstar CPMS Canadian database on the following factors:
- Deviations of 10-year earnings per share (EPS) and return on equity (ROE), which measure the consistency of earnings and shareholder returns over the past decade. Lower values are better;
- Three-year deviation of total return, which measures the volatility of the stock price itself. Lower values are better;
- Forward price-earnings-to-growth, or PEG ratio, a classic growth-at-a-reasonable price metric that divides the forward price-to-earnings ratio by the estimated growth rate of earnings as predicted by Street analysts. The idea here is to compare the valuation relative with the growth rate. Lower values are better.
Also, only companies with a market cap of more than $570-million were considered. This limit is meant to exclude the bottom half of the stock universe by size.
What we found
I used Morningstar CPMS to backtest the strategy from December, 1995, to June, 2021, assuming a 15-stock portfolio that never holds more than four stocks per economic sector.
Once a month, stocks were sold if they fell below the top 25 per cent of the universe based on the specified metrics. When sold, a stock was replaced with the next qualifying stock not already held in the portfolio, keeping in mind the sector limits.
On this basis, the strategy produced an annualized total return of 15.5 per cent, while the S&P/TSX Composite Total Return Index produced 8.5 per cent. In the 12 months ended June, 2021, the strategy produced a 61.1-per-cent return, while the index returned 33.9 per cent.
This article does not constitute financial advice. It is always recommended to speak with a financial adviser or professional before investing.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors.
Morningstar Direct is the firm’s multiasset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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