What are we looking for?
Stable Canadian companies outpacing their peers in earnings growth.
The screen
As the S&P/TSX Composite Index continues to flirt with record highs, cautiously optimistic investors may glean some ideas from today’s strategy, which looks for companies showing a good combination of quality and low volatility metrics, but are also outpacing their peers in short-term earnings growth. To find these companies, I use Morningstar CPMS to rank stocks in the S&P/TSX Composite on the following metrics:
- Industry-relative quarterly earnings momentum – on its own, earnings momentum compares the latest four quarters of operating earnings per share against the same number one quarter ago. “Industry-relative” means we compare this figure with the median of the sector to which the stock belongs. For example, a value of 4.2 per cent would show that the stock’s quarterly earnings momentum figure is 4.2 per cent higher than that of its sector. Higher figures preferred;
- Five-year deviation of operating earnings and one-year standard deviation of total return. (Recall that deviation is a statistical measure, essentially quantifying consistency. Today, we measure the consistency of both the stock’s total return – share price appreciation plus dividends – as well as its operating earnings, lower figures preferred);
- Five-year average return on equity;
- Five-year historical price beta (a measure of sensitivity, in this case to the S&P/TSX Composite. In trending markets, a beta less than one implies that the stock has historically moved less than the market, lower figures preferred).
Real estate investment trusts were purposely excluded in today’s analysis as they tend to trade more on cash flow metrics as opposed to earnings.
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 January, 1999, to the end of September, 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 35 per cent of the index. Over this period, the strategy produced an annualized total return of 11.9 per cent while the S&P/TSX Composite advanced 7 per cent on a total return basis. In calendar year 2018, on the same basis, the strategy gained 4.2 per cent while the index lost 8.9 per cent.
Only 10 stocks qualify for purchase today and 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.
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Ian Tam, CFA