What are we looking for?
U.S.-listed stocks that combine value, momentum and quality.
Previously, I screened for Canadian stocks that exhibit a good combination of value, momentum and quality metrics to combat the cyclical nature of the Canadian equity market. South of the border, equity markets are far more efficient, arguably less cyclical and widely diversified across the full economy. On the back of the U.S. Federal Reserve’s recent rate cut (which historically has boosted equity market performance), I used Morningstar CPMS to help understand whether a similar multifactor approach would also work in the U.S. market. To find companies exhibiting these characteristics, I ranked the stocks in the S&P 500 on the following metrics.
- Value: price-to-earnings, price-to-book and price-to-sales ratios relative to the industry median (in the table, a value of 0.9 means that the valuation metric is 10 per cent lower than the sector to which it belongs);
- Momentum: three-month and six-month price change (higher figures preferred);
- Quality: five-year average return on equity and five-year deviation of earnings (a safety metric measuring how volatile a company’s earnings have been over the past five years, lower preferred).
To qualify, companies must have a positive trailing return on equity.
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 December, 1998, to June, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than three per economic sector. Once a month, stocks were sold if their rank fell below the top 25 per cent of the universe, if estimates fell by more than 10 per cent over the trailing three months or if the company reported a negative return on equity. 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 9.3 per cent while the S&P 500 Total Return Index gained 6.4 per cent. The maximum drawdown (the percentage change in the portfolio value, measured from peak to trough over consecutive months) for the portfolio was minus 29.4 per cent (May, 2007, to February, 2009) while the maximum drawdown for the index was minus 51 per cent (October, 2007, to February, 2009), which speaks to the defensive nature of this model.
The stocks that qualify for purchase today are listed in the table below. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
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.