What are we looking for?
Canadian consumer cyclical stocks that are fighting for earnings in a slowing space.
The screen
Despite commentary pointing to tighter pockets for the Canadian consumer, 65 of the 94 companies classified as consumer defensive or consumer cyclical sectors have posted positive returns on a year-to-date basis. Investors who believe comments on consumer spending are exaggerated can look to this week’s strategy, which looks for profitable companies in the consumer cyclical sector that are growing their top and bottom lines. To find these companies, I used Morningstar CPMS sort the 64 companies in this sector by the following metrics:
- Trailing return on equity and three-year average return on equity (to ensure consistent profitability);
- Net profit margin from their most recently reported quarter;
- Quarterly and annual sales momentum (past four quarters of top-line revenue, compared against the same figure a quarter ago and four quarters ago, respectively);
- Quarterly earnings momentum (similar to sales momentum, but uses bottom-line earnings);
- Five-year earning per share (EPS) deviation (a statistical measure showing how volatile a company’s earnings have been, lower figures preferred).
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 covers 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 May, 1992, to February, 2019. During this process, a maximum of 10 stocks were purchased and equally weighted. Once a month, stocks were sold if their rank fell below the top 50 per cent of the ranked universe, or if any of the above momentum or trailing ROE figures turned negative. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Assuming a 1-per-cent liquidity cost (which assumes that stocks are purchased for 1 per cent higher than their close, and sold for 1 per cent lower), the strategy produced an annualized total return of 16.3 per cent while the S&P/TSX Consumer Discretionary Total Return Index produced a return of 7.7 per cent.
The stocks that qualify for purchase today are listed in the table here. 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.
Ian Tam, CFA