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What are we looking for?

Stocks in Canada’s underrated tech sector.

The screen

For many equity investors, the Canadian technology sector leaves much to be desired when compared with our neighbours south of the border. Relative to giants such as Facebook Inc. and Amazon.com Inc., Canada’s technology names are certainly smaller, but this doesn’t mean that there are not opportunities for investors, specifically those who are willing to delve into small- and mid-cap names. This week, I use Morningstar CPMS to rank stocks within the Canadian technology sector (today, this comprises just 45 names within the CPMS database) on the following metrics:

  • Trailing re-investment rate (the percentage of a company’s earnings per share not paid out in dividends, with the idea that they invest these earnings into future growth, higher figures preferred);
  • Latest reported return on equity;
  • Quarterly earnings momentum (past four quarters of operating EPS compared with the same figure one quarter ago, higher figures preferred);
  • PEG (price-earnings to growth) ratio on re-investment rate (a growth-at-a-reasonable-price, or GARP, measure comparing the price-to-earnings ratio of a stock with its re-investment rate, lower figures preferred).

To qualify, companies must have reported a positive operating EPS over the trailing four quarters, and must have a debt-to-equity ratio less than 0.25 (sorting by D/E, this screen excludes the top one-third of stocks in our universe to avoid overly leveraged companies). Only stocks with a market cap of $200-million or higher were considered.

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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 110 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 December, 1991, to April, 2018. During this process, a maximum of seven stocks were purchased and equally weighted. Once a month, stocks were sold if their rank fell below the top half of the ranked universe, or if the trailing four quarters of EPS turned negative. 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 17.2 per cent while the S&P/TSX Information Technology Total Return Index gained 3.1 per cent.

The stocks that meet our requirements for purchase are listed in the table below. It is always recommended to speak to a financial adviser or investment professional before investing.

Select Canadian tech stocks

RankCompanyTickerMorningstar IndustryMarket Cap ($Mil)Trailing 4Q Operating EPS ($)Trailing ROE (%)Qtrly Earns Momentum (%)PEG RatioTrailing Re-investment Rate (%)D/EDividend Yield (%)Recent Price ($)Price Chge from month end, 12M ago (%)
1Points InternationalPTS-TInternet Content & Information 248.2 0.8222.116.01.122.30.000.017.2030.1
2Kinaxis Inc.KXS-TSoftware - Application 2,099.4 1.5424.34.24.319.30.000.081.88-9.0
3CGI Group Inc.GIB.A-TInformation Technology Services 19,755.7 3.9717.63.71.016.80.220.077.2515.4
4Real Matters Inc.REAL-TSoftware - Application 513.5 0.072.830.411.52.80.000.05.82-53.6
5Evertz TechnologiesET-TCommunication Equipment 1,307.8 0.8820.73.62.03.90.004.217.102.8
6Descartes SystemsDSG-TSoftware - Application 2,968.1 0.9111.63.33.410.90.070.038.6614.4
7Enghouse Systems Ltd.ENGH-TSoftware - Application 1,762.9 1.8216.5-0.33.110.70.011.165.0810.2

Source: Morningstar Canada

Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.

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