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What are we looking for?

Canadian value stocks with a positive ESG screen.

The screen

Investing focused on ESG (environmental, social and governance) issues is a trend that continues to be on the rise. More and more investors are speaking with their financial adviser about how they can hold investments while not violating their core beliefs. It’s almost to the point where at least some knowledge on the topic of ESG is a necessity for financial advisers.

A common question is how to combine a respect for one’s ESG beliefs with one’s strictly financial opinions. Take, for example, investors who prefer to buy value stocks (recall that value stocks are those that trade below their intrinsic value): How can ESG be incorporated alongside that strategy?

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Today I’ve created a model that searches for Canadian value companies and also considers ESG within the CPMS Canadian universe (today this universe holds 700 names). The strategy ranks stocks based on:

  • Overall ESG score, according to Sustainalytics – measures how a company pro-actively manages the ESG issues that most affect their business; scores are from 0-100, with 100 being the best;
  • Price-to-book value – a value metric, low values are preferred;
  • Price-to-trailing earnings – a company’s share price divided by its most recent four quarters of earnings, low values preferred.

In order to qualify, stocks must have an overall ESG score in the top one-third of peers (today this value is greater than or equal to 58); stocks must also have a controversy score less than or equal to two; P/E and price-to-trailing-cash-flow in the bottom half of peers (today these values are less than 20.1 and 10.4 times respectively); lastly, stocks must have a five-year beta relative to the S&P/TSX Composite Index less than or equal to one.

(Controversy score is an assessment, on a scale of one to five, of how much a public debate or dispute related to the company is affecting stakeholders, five being the most severe impact. Price-to-trailing-cash-flow is a value metric similar to P/E, using trailing four quarters of cash flow in the denominator, low values are preferred. Beta is a measure of the sensitivity of a stock relative to its benchmark, low values preferred.)

More about Morningstar and Sustainalytics

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. Sustainalytics, a leading independent global provider of ESG research and ratings, is a strategic partner to Morningstar. The firm’s company-level ESG ratings underpin Morningstar’s sustainability rating for funds.

What we found

I used Morningstar CPMS to back test this strategy from August, 2009, to October, 2018. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their price-to-trailing-earnings rose above the top third of peers or if their highest controversy score was greater than three. 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 15.2 per cent while the S&P/TSX Total Return Composite gained 6.7 per cent across the same period. It’s also worthwhile to note that in all quarters over this period where the index showed negative returns, our strategy beat the benchmark 100 per cent of the time.

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 below.

Select TSX stocks that meet value and ESG criteria

Rank Company Ticker Market Cap ($Mil) Recent Price ($) Div. Yield (%) 1Yr Price Chg (%) P/E P/B Price to CF Controversy Score (0-5)
1 Cascades Inc. CAS-T 1,064.8 11.29 1.4 -12.1 12.4 0.7 3.1 0.0
2 Celestica Inc. CLS-T 1,574.2 13.25 0.0 -5.4 9.7 1.1 8.6 1.0
3 Power Corp. of Canada POW-T 11,159.4 26.76 5.7 -18.1 8.0 0.9 1.6 1.0
4 Bank of Montreal BMO-T 62,553.7 97.69 3.9 -1.6 11.3 1.6 8.2 2.0
5 Sun Life Financial Inc. SLF-T 29,331.8 48.53 4.1 -4.8 10.3 1.4 4.4 2.0
6 Cogeco Communications CCA-T 2,149.1 63.42 3.3 -31.1 10.9 1.6 4.3 0.0
7 Power Financial Corp. PWF-T 20,009.0 28.02 6.2 -20.7 8.5 1.1 2.6 2.0
8 Artis REIT AX-UN-T 1,525.9 9.92 5.4 -29.6 7.9 0.7 6.9 0.0
9 Telus Corp. T-T 28,384.3 47.45 4.6 -0.5 17.1 2.9 7.2 2.0
10 Transcontinental Inc. TCL-A-T 1,856.8 21.14 4.0 -24.0 7.9 1.2 3.7 0.0
11 Air Canada AC-T 7,138.7 26.17 0.0 6.4 11.2 1.6 3.0 2.0
12 BCE Inc. BCE-T 50,468.3 56.20 5.4 -9.0 16.7 3.0 7.3 2.0
13 Great-West Lifeco Inc. GWO-T 30,234.6 30.59 5.1 -12.9 10.0 1.4 4.2 2.0
14 Atco Ltd. ACO-X-T 4,610.6 40.17 3.7 -12.8 13.6 1.3 4.6 1.0
15 Fortis Inc. FTS-T 19,732.8 46.25 3.9 -2.6 18.3 1.4 7.0 2.0

Source: Morningstar CPMS

Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.

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