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What are we looking for?

Profitable Canadian companies avoiding controversy.

The screen

With choppy equity markets keeping investors on edge, unexpected company-specific news can often act as gasoline on a fire. Today’s hyperaware newsfeeds can often be a cause of confusion and in some cases drastically affect the market price of a holding, often to the detriment of the investor. With this in mind, today I use Morningstar CPMS in conjunction with data from Morningstar Sustainalytics to look for profitable Canadian-listed companies that have generally avoided significant controversial news.

Revisiting the concept of looking at environmental, social and governance factors as a source of risk management, the strategy leverages a proprietary measure known as controversy level. This measure is sourced from roughly 60,000 news sources to determine whether there might be financially material impacts from 10 ESG-related topics, including: business ethics, society and community, operations, environmental supply chain, product and service, employee relations, social supply chain, customers, corporate governance and public policy.

News is assessed based on the negative environmental and/or social impact of the company activity as well as the reputational risk that the activity poses to the company. The controversy measure ranges from one (a low impact on the environment and society, and risks to the company are minimal or negligible) to five (a severe impact on the environment and society, posing serious business risks to the company). A score of five would represent exceptionally egregious corporate behaviour, high frequency of recurrence, very poor management of ESG risks and a demonstrated lack of willingness by the company to address relevant risks.

Today’s strategy screens for companies with low controversy levels alongside traditional financial metrics (with a tilt to quality and growth) including:

  • Five-year average return on equity;
  • Five-year sales and earnings per share growth rates (on average, how much top and bottom line has grown each year over the past five, higher figures preferred);
  • Five-year deviation of return on equity and EPS (volatility metrics that measure the consistency of profitability and earnings, lower figures preferred);
  • Cash-flow-to-debt (an increasingly important measure as interest rates start to rise and companies must ensure they have enough cash to cover interest expenses, higher figures preferred).

To qualify, stocks must have a market capitalization great than $580-million, a figure representing the median stock in the universe database (consisting of 704 companies).

What we found

Quietly profitable Canadian stocks that steer clear of controversy

RankCompanyTickerMorningstar SectorMkt. Cap. ($ Mil.)5Y Avg. ROE (%)5Y Sales Grth. Rate (%)5Y EPS Grth. Rate (%)5Y Dev. of ROE (%)5Y Dev. of Earns. (%)CF/DebtESG Contrsy. Level Div. Yld. (%)12M Ttl. Rtn. (%)Recent Close ($)
1Enghouse Systems Ltd.ENGH-TTechnology1,965.219.811.219.11.88.09.102.1-38.735.35
2Equitable Group Inc.EQB-TFin'l Services1,976.815.611.413.81.18.5n/c01.9-13.258.02
3Calian Group Ltd.CGY-TIndustrials776.016.78.415.91.610.33.401.619.768.59
4Constellation SoftwareCSU-TTechnology43,639.095.318.417.24.44.51.100.212.92,059.27
5iA Financial Corp.IAG-TFin'l Services7,185.912.412.611.70.75.41.913.7-1.666.81
6Manulife FinancialMFC-TFin'l Services48,471.812.310.18.20.95.12.015.3-2.425.13
7Richelieu HardwareRCH-TCons. Cyclical2,067.116.811.619.62.919.52.401.4-13.136.85
8CGI Inc.GIB-A-TTechnology22,359.518.97.410.01.02.40.50n/a-3.9104.87
9Waste ConnectionsWCN-TIndustrials44,227.810.56.18.90.74.00.310.717.2171.99
10North West Co. Inc.NWC-TCons. Defensive1,688.723.94.719.24.718.60.804.24.535.27

Source: Morningstar CPMS and Morningstar Sustainalytics; data as of May 3

Note: EQB does not currently have outstanding long term debt, hence cash-flow-to-debt is not calculable. 

I used Morningstar CPMS to back-test the strategy from August, 2009, to March, 2022, assuming an equally weighted 15-stock portfolio with no more than four stocks per economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics, or if the controversy level exceeded one. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, considering the aforementioned sector limits. On this basis, the strategy produced an annualized total return of 13 per cent, while the S&P/TSX Composite Total Return Index advanced 8.9 per cent on the same basis. Today, only 10 stocks meet the requirements to be purchased into the strategy. They are listed in the accompanying table.

Notably, several companies on the screen have a controversy score of zero, implying that Morningstar Sustainalytics has not detected news flow in relation to the 10 controversial areas.

This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.

Ian Tam, CFA, is director of investment research for Morningstar Canada.

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