What are we looking for?
The iShares S&P/TSX 60 Index ETF (XIU) broke above key resistance at the $25 level to make new record highs this month, posting an impressive 30.5-per-cent return year-to-date. By comparison, in the U.S. market the iShares Core S&P 500 Index ETF (XSP), which is hedged to the Canadian dollar, is up 19.2 per cent this year.
The S&P/TSX Composite industrials sector has gone in the opposite direction of the S&P/TSX Composite Index so far this month (down 2.3 per cent versus up 2.8 per cent, respectively), but we have noticed some short-term support in the sector. Normally, the TSX industrial sector is fairly correlated to the S&P/TSX Composite, however it has fallen from an average correlation of more than 80 per cent back in May to 74 per cent this week.
Today we look for stocks in the Canadian industrial sector that may benefit from an unusual decline in correlation to the S&P/TSX Composite.
We will be using Trading Central Strategy Builder to search for Canadian industrial stocks offering reasonable valuations and efficient operations. We begin by setting a minimum market-capitalization threshold of $500-million. This helps us find well-established companies in the market by size.
Next, we will look for companies indicating efficient operations as measured by their operating margin. We will screen for industrials with operating margins of 5 per cent or more. Operating margin is a key statistic that shows how profitable the company’s core business is, as it does not include interest, taxes and some non-core/non-recurring revenue items. Higher operating margins are preferred.
In addition, to ensure a company’s operations are scalable, we will look at revenue per employee. We will select only companies with revenue per employee of $100,000 or more. Companies with high revenue per employee are better able to scale up their revenues without adding lots of new employees.
Next, we will search for companies that have a Columbine Capital Quant Ranking between one and five. The Columbine Capital Quant Rank is a proprietary stock ranking methodology developed by Colorado-based Columbine Capital Services Inc. that ranks stocks on a scale of one to 10, with one being the most bullish and 10 being the most bearish.
Finally, I capped the price-to-earnings ratio at 28 in order to find companies with reasonable valuations compared with the S&P/TSX Composite industrial sector average of 25.
More about Trading Central
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What did we find?
Topping our list is Canadian Pacific Railway Ltd. The current operating margin is at 40.5 per cent, the second-highest on our list. The stock has recently pulled back to its 200-day moving average as it tests support from 2018 highs. Even with the sharp pullback this month, prices are still up more than 20 per cent year-to-date.
Russel Metals Inc. is one of the largest metals distribution and processing companies in North America. It has the highest dividend yield on our list at 7.3 per cent. Although year-to-date performance is relatively flat, the stock has been trading below its 50-day moving average for most of the year until its breakout earlier this month. A break above its 200-day moving average around $22.20 might just mark the end of its long-term down trend in place since February, 2018.
Trading Central Strategy Builder provides a back-testing capability to evaluate how well an investing strategy would have worked in the past. Using a five-year historical period with quarterly rebalancing, the screen described had a 28-per-cent annualized return compared with 16.3 per cent for the S&P/TSX 60 Index.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.
Gary Christie is head of North American research at Trading Central.
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