What are we looking for?
U.S. companies that are steadily growing earnings.
U.S. equity markets seem relatively unfazed by the continued trade tensions with China, following a correction in late 2018. Year-to-date, the S&P 500 Total Return Index is up 18.2 per cent (it lost 13.5 per cent in the fourth quarter of 2018). For investors who believe this trend is to continue for some time to come, today’s strategy may provide some investment ideas focusing on companies with steadily growing earnings. To find said companies, I use Morningstar CPMS to rank the stocks in the S&P 500 on the following metrics:
- Five-year earnings deviation (a statistical measure that shows how steady a company’s earnings have been over the past five years, lower figures preferred);
- Quarterly earnings momentum (the past four quarters of operating earnings compared with the same figure, one quarter ago, higher figures preferred);
- Three-year earnings-per-share growth rate (on average, how much earnings have grown annually over the past three years);
- Three-month price momentum (the average share price over the past six months compared with the average share price over the six-month period ended three months ago, higher figures preferred).
To qualify, companies must have a debt-to-equity ratio in line or lower than the sector median (in the accompanying table, a figure of 0.9 would imply that the company is 10-per-cent less leveraged than the median of the sector to which it belongs). Additionally, only companies with positive reported return on equity are considered.
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 January, 2007, to March, 2019. During this process, a maximum of 10 stocks were purchased and equally weighted with no more than three for each economic sector. Once a month, stocks were sold if their rank fell below the top 25 per cent of the S&P 500 based on the aggregate of the above factors or if the company reported a negative return on equity. 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 10.5 per cent while the S&P 500 Total Return Index gained 8 per cent.
The stocks that qualify for purchase today are listed in the accompanying table. 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.