What are we looking for?
Stocks to help jittery investors play defence.
Various market participants are concerned about the potential for a correction. Investors are reminded that market sentiment is always fickle, and no one gets it right 100 per cent of the time. Still, it is hard to ignore the discomfort in holding stocks in a market that has performed well after a major correction. To this end, today I use Morningstar CPMS to look for Canadian-listed companies that show the characteristics desirable for nervous investors, with the intent to create a strategy that is less volatile than the benchmark but able to produce steady gains over time. To find these companies, I first ranked the 711 stocks in our database on the following metrics:
- Five-year historical price beta (remember that beta is a measure of a stock’s sensitivity to an index. Stocks with beta less than one have historically moved less than the index in trending markets. Lower betas are preferred here);
- Ten-year average return on equity (a profitability metric, higher figures preferred);
- Ten-year deviation of earnings (a measure of volatility, lower figures preferred, implying that earnings have been consistent over the past 10 years);
- Five-year deviation of total return (similar to the prior measure but this time measuring the movement of the stock, lower figures preferred).
Only stocks with a market float of at least $420-million were considered, a figure meant to exclude the bottom half of the universe by size. Recall that market float is the total dollar value of a company that is available to be traded publicly. Additionally, we looked for companies that: yield 2.7 per cent or greater (which excludes the bottom half of the universe by yield); exhibit a payout ratio against earnings of less than 80 per cent or against cash flows of less than 60 per cent.
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 multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
I used Morningstar CPMS to back-test the strategy from January, 2004, to August, 2021, assuming a 20-stock portfolio that holds no 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 above metrics or both payout ratios mentioned above exceeded their limits. When sold, stocks were replaced with the next qualifying stock not already held in the portfolio, keeping in mind the aforementioned sector limits. On this basis, the strategy produced an annualized total return of 11.1 per cent, while the S&P/TSX Composite Total Return Index produced 8.1 per cent.
The stocks that meet requirements to be purchased into the strategy today are listed in the table. This article does not constitute financial advice. It is always recommended to speak with a financial adviser or professional before investing.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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