What are we looking for?
Momentum and growth within the S&P/TSX Composite Index.
The S&P/TSX Composite continues to be weighed down by depressed oil prices with only two of 25 energy stocks within the index showing positive returns on a year-to-date basis (with all others posting double-digit losses on the same basis). Despite this, the recovery period since the bottom of the market in March has provided opportunity for momentum-oriented investors to pick up companies in other sectors that have recovered quickly. This week, I look to find these types of companies by first ranking the stocks in the S&P/TSX Composite Total Return Index on the following factors:
- Five-year growth rates for cash flow and earnings per share (which measure on average how much operating cash flow and earnings have grown each year in the past five);
- Quarterly earnings momentum (a comparison of the most recent four quarters of operating earnings against the same figure one quarter ago, higher figures preferred);
- Three-month estimate revisions (a sentiment indicator measuring the median Street analyst consensus on fiscal year earnings against what it was three months’ prior. When this figure is positive, it indicates that Street analysts, on the whole, are showing a bullish change in sentiment);
- Latest earnings surprise (the difference between the latest reported earnings and the Street estimate just prior to earnings being released, higher figures preferred);
- Three-month price momentum (which is calculated as the average price over the past six months as a percentage change from the same figure three months ago).
To qualify, companies must have a sector-relative debt-to-equity ratio less than one (implying that the debt-to-equity of the company is lower than that of the sector to which it belongs).
More about Morningstar
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What we found
I used Morningstar CPMS to back-test this strategy from April, 1995, to July, 2020, using a maximum of 15 stocks with no more than three per economic sector. Once a month stocks were sold if their rank dropped below the top half of the index based on the factors listed above. Over this period the strategy produced an annualized total return of 13.2 per cent while the S&P/TSX Composite Total Return Index advanced 8 per cent over the same time frame. On a year-to-date basis ended July 31, the strategy has produced 21.7 per cent while the index lost 3.3 per cent. That said, investors are reminded that fast-moving momentum strategies are a double-edged sword: During the financial crisis, this strategy lost 46.5 per cent of its value while the index lost 43.4 per cent.
Only 10 stocks meet the requirements to be purchased into the model today and they are listed in the table below.
This article does not constitute financial advice. It is always recommended to speak to a financial adviser or professional before investing in any of the products listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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