What are we looking for?
High-quality companies garnering positive sentiment from Street analysts.
The screen
In a recent article, The Globe and Mail highlighted Mark Carney’s thoughts on the state of the Canadian economy and the possibility of a looming recession. In short, Mr. Carney doesn’t think things will be as bad as they were in the financial crisis of 2008. Even still, investors are likely still on edge given where interest rates are going (up) and high inflation and already-rock equity markets.
As such, today we seek companies with a long history of stable and growing earning and profitability, that have garnered positive analyst sentiment. As readers will see below, these types of fundamental characteristics served investors well during the financial crisis. To find such companies today, I used Morningstar CPMS to first rank the 709 stocks in our Canadian database on the following factors:
- 10-year EPS growth rate (on average, how much bottom-line earnings-per-share have grown each year over the past 10);
- 10-year average return on equity, or ROE (a profitability metric that divides net income by shareholder equity, averaged over 10 years);
- 10-year deviation of ROE and EPS (measuring the consistency of the above two measures, lower preferred);
- Three-month EPS estimate revisions (a measure of analyst sentiment, comparing today’s median consensus estimate on earnings against the same figure at month end, three months ago).
To qualify, stocks must have a market cap greater than $500-million, a figure meant to exclude the bottom half of the database by size. Additionally, only stocks with at least three active analysts estimates were considered, to ensure a reasonable consensus. Finally, a screen was placed on the sector-relative debt-to-equity ratio, such that only companies that are less leveraged than their sector peers were considered. In the table, a figure of 0.9 would imply that the company is 10-per-cent less leveraged than the sector to which it belongs.
What we found
I used Morningstar CPMS to back-test the strategy from December to May, 2022, assuming an equally weighted 20-stock portfolio with no more than four stocks a sector. Once a month, stocks were sold if they fell below the top 35 per cent of the ranked list based on the above metrics, or if the three-month EPS estimate revision fell beyond -10 per cent (signalling bearish sentiment from the Street). When sold, stocks were replaced with the next qualifying stock not already held in the portfolio.
On this basis, the strategy produced an annualized total return of 13.1 per cent, while the S&P/TSX Composite total return index produced 8.4 per cent on the same basis. In 2008, the strategy fell by 25.4 per cent while the index fell by 33 per cent, outlining its defensive nature. The stocks that meet the requirements to be purchased into the strategy today are listed in the accompanying table.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.
Ian Tam, CFA