What are we looking for?
Canadian stocks that are viewed favourably by equities analysts.
A useful tool for investors to use when looking at potential companies to purchase is research produced by analysts. These reports contain their researched opinions as to what a stock is worth and where it currently sits relative to that worth. One of the most commonly recognized and easily understood outputs from analysts are the stock ratings of buy, sell and hold.
Today, I’m showcasing a strategy that looks across the CPMS Canadian universe for stocks that are viewed favourably by analysts. The CPMS Canadian universe currently contains 701 names.
In order for stocks to qualify, this strategy requires:
- A median analyst recommendation greater than or equal to three. (Analysts can score companies on a scale of one to five, one being the least favourable and five being the most favourable, which is the definition used by Morningstar. A similar, well-known scale can also be referenced to aid with interpretation: five, strong buy; four, moderate buy; three, neutral or hold; two, moderate sell; and one, strong sell.)
- A three-month change in median analyst recommendation greater than or equal to zero (measure of the change in analyst recommendation across the trailing three-month period; for example, if three months ago a stock was rated as a two and is now rated a four, the three-month change would be two);
- A five-year beta relative to the index less than or equal to one (a measure of benchmark sensitivity; here we use the S&P/TSX Composite Index);
- A three-month earnings-per-share estimate revision (measures the change in EPS estimates across the trailing three-month period) that is positive or unchanged;
- A market capitalization greater than or equal to $100-million.
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, 1996, to June, 2019. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their five-year beta rose higher than 1.2 or if their three-month change in median analyst recommendation dropped below zero. 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 19.1 per cent while the S&P/TSX Composite Total Return Index returned 7.1 per cent across the same period.
Downside deviation (measured as the variability of negative returns) was 7.8 per cent compared with 10.2 per cent for the S&P/TSX Total Return Index. One important thing to note is that the turnover on this model was quite high, at 181 per cent. What this means is that you could be replacing the 15 stocks in the portfolio almost twice each calendar year were you to follow this model exactly. This amount of trading may be too high for some investors to manage themselves, however those curious to learn more should speak with their financial adviser.
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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