What are we looking for?
Canadian momentum stocks.
For those who are looking for higher returns and don’t mind taking on some additional risk, momentum investing can be a popular style to consider. Recall that momentum investing looks for uptrends in a particular security’s characteristics, such as price, revenues, earnings, etc. While these characteristics can help guide investors to strong momentum stocks, they can also unearth unfamiliar, smaller-cap names that may have both momentum and heightened volatility. One way to combat this is to set a universe for your model that restricts itself to names in a well known index, while still looking for momentum features.
Today, I’ve built a strategy that searches for companies showing positive momentum trends within the investment universe of the S&P/TSX Composite Index. This strategy ranks stocks based on:
- Price change from 12-month high (a momentum factor, least-negative values are preferred);
- Quarterly earnings momentum (measured as the growth in the most recent trailing four quarters of earnings relative to the same four quarters’ earnings lagged by one quarter, higher values preferred);
- Quarterly sales momentum (measured as the growth in the most recent trailing four quarters sales relative to the same four quarters’ sales lagged by one quarter, higher values preferred);
- Industry-relative surprise in earnings per share (measured as the change between a company’s earnings surprise relative to the industry’s earnings surprise to which the company belongs, higher values preferred);
- Stock’s must have a five-year price beta (measure of the sensitivity of a stock relative to a benchmark – here we used the S&P/TSX – low values preferred) less than one; an industry-relative EPS surprise greater than zero, and a price relative to the stock’s 200-day moving average greater than 3 per cent.
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 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 February, 1999, to September, 2019. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their price relative to the stock’s 200-day moving average fell below minus 10 per cent. 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 15.1 per cent while the S&P/TSX Composite returned 7.5 per cent on a total return basis over the same period. One thing worth noting is that the strategy’s downside deviation (a measure of the volatility of negative returns) was 7.4 per cent relative to the benchmark’s downside deviation of 9.3 per cent. 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 here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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