What are we looking for?
Canada’s most profitable companies.
This week, I use Morningstar CPMS to find companies that have shown consistently high profit margins over the trailing five quarters. To find these companies I first rank the companies in the CPMS Canadian Universe (today consisting of roughly 700 names) on the following metrics:
- Quarterly earnings and sales momentum (latest four quarters of operating earnings and revenues compared with the same figure, respectively, one quarter ago);
- Latest reported return on equity (not shown);
- Five-year historical beta (a safety measure showing how sensitive, historically, a stock is to the index. A stock with a beta of 0.6, for example, would imply that for every percentage point the benchmark moves up or down, the stock moved by 0.6 of a percentage point.)
To qualify, stocks must have a net profit margin in each of the past five quarters greater than the median net profit margin of the universe during that same quarter (the figure for four quarters ago not shown). Today, the median net profit margin for stocks in our universe is 5 per cent. Additionally, only companies with a market cap of greater than $100-million were considered (this figure is meant to exclude the bottom one-third of stock in the universe by market cap). Unit trusts and real estate investment trusts were excluded in the above analysis.
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.
What we found
I used Morningstar CPMS to back test this strategy from November, 2002, to April, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four for each economic sector. Once a month, stocks were sold if their rank fell below the top 35 per cent of the ranked universe or if they reported a negative net profit margin. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio.
A 1-per-cent liquidity cost was applied to this test (implying that stocks were bought at 1-per-cent higher and sold for 1-per-cent lower than their close price) to account for some of the less liquid names in this strategy.
Over this period, the strategy produced an annualized total return of 12 per cent while the S&P/TSX Composite Total Return Index gained 9.6 per cent.
The stocks that qualify for purchase today are listed in the accompanying table. 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.