What are we looking for?
U.S. basic material stocks with attractive fundamentals and positive earnings growth.
Looking at sector performance over the past week, the Materials Select Sector SPDR ETF (XLB) has returned more than 5 per cent, jumping ahead of defensive leaders such as the Utilities SPDR ETF (XLU) and the Real Estate Select Sector SPDR ETF (XLRE).
We will be using Trading Central Strategy Builder to search for stocks in the materials sector, which has started to post a rebound after declining 26 per cent off its record high set back in January, 2018.
We begin by setting a minimum market capitalization threshold of US$1-billion to focus on larger, more established companies in the sector.
Next, we will look for companies that are profitable and have an operating margin of 10 per cent or more. Operating margin is a measure of how much profit a company makes on each dollar of revenue. We will also screen for debt-to-equity ratios of 1.0 or less in order to focus on companies with low levels of debt.
Finally, we will screen companies that have grown their earning per share a minimum of 5 per cent over the past five years.
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What we found
Topping our list is Franco-Nevada Corp. The company owns a diversified portfolio of precious metals and royalty streams, which is actively managed to generate the bulk of its revenue from gold, silver and platinum. Franco-Nevada’s short-term financial performance is linked to the price of commodities and the amount of production from its portfolio of producing assets. Nothing influences gold prices quite like Federal Reserve policy in the short and intermediate term. With a possible flattening to inverted yield curve and a current 75-per-cent probability that the Fed will either keep the target rate the same, or a 25-per-cent chance it lowers rates a quarter point at the next meeting on June 19, gold prices should benefit. We have noticed gold already breaking above its long-term down trends.
Franco-Nevada ranks at the top of all companies on our list owing to its operating margin of 40.5 per cent, annual earnings growth of 56 per cent over the past five years and the lowest debt-to-equity ratio of 0.03.
Teck Resources Ltd. grabbed our attention. Teck is a diversified miner with zinc, copper, coal and oil sands operations in Canada, the United States, Chile and Peru. Teck ranks as the world’s second-largest exporter of seaborne metallurgical coal and is a top-three zinc miner. The company has been buying back shares and reducing debt over the past five years. The company has the second best operating margin on our list at 28.5 per cent and a low debt-to-equity ratio of 0.29.
The large decline in the materials sector over the past two years may be giving us some opportunities to play the rebound. Risk management is critical when trading in volatile markets. Always have an exit plan before entering into a position.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.
Gary Christie is head of North American research at Trading Central.