What are we looking for?
Canadian companies on a tear but still showing value relative to peers.
As the S&P/TSX Composite Index claws its way back toward prepandemic levels (we hope), Canadian investors have been treated to a whipsaw-like recovery period. In times of volatility, it may prove useful to look at how stocks are trading relative to their peers before buying to ensure you are not overpaying for short-term price movements. For some ideas, this week I use Morningstar CPMS to rank the 250 largest companies in Canada on the following key metrics:
- Quarterly earnings momentum (an earnings growth metric measured as the past four quarters of operating earnings compared against the same figure one quarter ago, higher figures preferred);
- Five-year deviation of earnings (a statistical measure that measures consistency of earnings, lower figures preferred);
- Six-month total return (we measure from month-end, six months ago).
I then screened for companies that are trading at or below peers on at least one of four common valuation metrics: price-to-book, price-to-earnings, price-to-cash flow and price-to-sales. In the table, a value of 0.9 signifies that the stock’s multiple is 10 per cent lower than that of the sector to which it belongs. To qualify, at least one of these sector-relative value multiples must be at or below one. Additionally, to ensure profitability, only companies with positive return on equity were included.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
I used Morningstar CPMS to backtest this strategy from May, 1992, to May, 2020, using a maximum of 15 stocks with no more than three for each economic sector. Once a month stocks were sold if they dropped below the top 35 per cent of the universe based on the factors listed above, or if all of a stock’s sector-relative multiples were 1.3 or above, that is, 30 per cent higher than its sector.
Over this period the strategy produced an annualized total return of 13.1 per cent while the S&P/TSX Composite Index advanced 8.1 per cent on the same basis. Only 10 stocks meet the requirements to be purchased into the model today and are listed in the accompanying table.
This article does not constitute financial advice. It is always recommended to speak to a financial adviser or professional before investing in any of the products shown here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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.