What are we looking for?
Less risky U.S. stocks to start the new year.
The S&P/TSX Composite Index finished 2019 with gains for the year of 22.9 per cent on a total return basis, while the S&P 500 posted a whopping 31.5 per cent. While some investors remain extremely positive heading into the new decade, others prefer to take a more conservative approach. A portfolio focused on lower volatility could help protect last year’s gains by better withstanding any possible future market instability.
As a follow-up to my recent column on Canadian equities, today’s strategy looks for a portfolio of U.S. stocks with downside protection within the CPMS U.S. universe, which today consists of 2,105 stocks.
This strategy ranks stocks based on two criteria: five-year beta and industry-relative earnings variability.
Five-year beta measures a company’s sensitivity relative to historical changes in the benchmark – here, we use the S&P 500. In trending markets, a stock with beta less than one has historically moved less than the index; low values are best.
Industry-relative earnings variability measures how volatile a company’s earnings are relative to its industry median; low or even negative values are best.
Stocks that qualify must have:
- Five-year beta of 0.8 or less (to reduce market sensitivity);
- Five-year standard deviation of monthly return on equity (a measure of risk) in the top half of peers (today this value is 3.1 per cent or less);
- Industry-relative earnings variability in the top two thirds of peers (this value today is 7.2 per cent or less).
- Market capitalization in the top half of peers (today this value is $3.5-billion or higher).
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 120 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, 2000, to November, 2019. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their five-year beta rose to 1.2 or higher. 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 10.9 per cent while the S&P 500 index returned 6.2 per cent on the same basis. The strategy outperformed in 92 per cent of down markets (measured as quarters where the S&P 500 experienced negative returns) compared with the benchmark.
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.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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