What are we looking for?
A portfolio of Canadian stocks with a low beta.
The screen
While there are a lot of different ways to measure stock volatility, beta remains my personal favourite. To summarize, beta is a measure of how sensitive a company is relative to changes in a defined benchmark (all references to beta within this article use the S&P/TSX Composite Total Return Index as the benchmark). A company with a beta less than one has historically moved less than the benchmark, so from a risk perspective, lower values of beta are considered preferable.
Today I’ve created a strategy that looks for Canadian stocks with a low measure of beta across three different time periods. The purpose of this strategy is to produce a portfolio that is less volatile than the market.
This strategy ranks stocks based on one-, three- and five-year beta (for all of which lower values are preferred). Stocks that qualify must have:
- Five-year beta less than one (to reduce market sensitivity);
- Historical earnings variability in the top two-thirds of peers (measure of the volatility of a company’s reported earnings per share; keeping in mind we are looking for lower-volatility stocks, today this translates to a value of 19.8 per cent or lower);
- Market cap in the top two-thirds of peers (today this translates to a market cap greater than $114.7-million).
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 110 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 October, 1990, to June, 2018. 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 14.2 per cent while the S&P/TSX Composite Total Return Index returned 8.9 per cent across the same period. Downside deviation (measured as the variability of negative returns) was 6.5 per cent compared with a downside deviation of 9.4 per cent for our benchmark. It is also worthwhile to note that during periods when the market declined (defined here as quarters the index had negative returns), the strategy outperformed 80 per cent of the time.
Stocks that qualify for purchase into the strategy today are listed in the table below. 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.
Emily Halverson-Duncan, CFA