What are we looking for?
Canadian tech companies on the rise.
Further downward pressure on the S&P/TSX Composite Index continued this week with the year-to-date return on our main benchmark index at minus 4.5 per cent. No sectors are immune to this, it seems, with the exception of information technology. The Canadian tech sector, often overlooked and albeit very small, has actually posted substantial positive gains year to date. In fact, the S&P/TSX Composite Information Technology Total Return Index has returned 19.6 per cent so far in 2018. Looking closer at the sector for profitable companies, we use CPMS to rank stocks (today this consists of just 38 companies) on the following metrics:
- Quarterly earnings and quarterly return on equity (ROE) momentum (this metric looks at the most recent four quarters of reported earnings or ROE, and compares this with the same figure one quarter ago);
- Latest reported return on equity;
- Five-year deviation of earnings (a statistical measure that shows how consistent earnings have been over the past five years, lower figures preferred);
- Three-month price momentum (average share price over the past six months compared with the same figure three months ago).
To qualify, companies must have a market cap above $67-million (eliminating the bottom one-third of stocks in our universe).
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 November, 2002, to November, 2018. During this process, a maximum of 10 stocks were purchased and equally weighted. Once a month, stocks were sold if their rank fell below the top 30 per cent of the ranked universe. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Because there are some small-cap companies that were included in this analysis, I’ve included a 0.5-per-cent liquidity cost (stocks are purchased for 0.5 per cent higher and sold for 0.5 per cent lower in the historical transactions). Over this period, the strategy produced an annualized total return of 15.2 per cent while the S&P/TSX Composite Information Technology Total Return Index produced 4.7 per cent.
The stocks that meet my requirements 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.