What are we looking for?
A strategy that combines momentum with quality.
For momentum investors, this year has been a dream. With three quarters of the year behind us, the domestic equity market has displayed some phenomenal results, shown largely by the S&P/TSX Composite Index, which has posted gains of more than 20 per cent year-to-date on a total return basis. Moreover, as of Tuesday’s close, 93 of the 233 companies in the S&P/TSX were trading within 5 per cent of their own 52-week highs.
Expanding on this statistic, I used Morningstar CPMS to create a momentum-oriented model purposely seeking companies trading close to their own 12-month highs by first ranking the 709 Canadian stocks in our database on this metric (the closer to the high, the better), then overlaying a series of screens to ensure some fundamental quality to the companies being chosen. Specifically, I used these screens:
- Five-year earnings per share deviation that is lower than the most volatile two-thirds of stocks in our database (recall deviation here refers to the consistency of reported earnings, and I am excluding the top two-thirds of our database by historical earnings volatility);
- Five-year EPS growth rate, five-year average return on equity, trailing return on equity and market float – all four metrics must be greater than the market median;
- A positive price change from month end, three months ago.
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 April, 1995, to the end of October, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than three per economic sector. Once a month, stocks were sold if their rank fell below the top 50 per cent of the universe, or if the company showed a negative trailing return on equity. Over this period, the strategy produced an annualized total return of 14.5 per cent while the S&P/TSX Composite Index gained 8.2 per cent on a total return basis. In calendar year 2018, the strategy lost 4.6 per cent while the index fell 8.9 per cent.
The stocks that qualify for purchase today are listed in the table below. 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.
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.