What are we looking for?
Undervalued Canadian stocks growing their dividends.
Given the recent market turbulence, dividend investors who are on the hunt for newly undervalued stocks may be interested in this week’s strategy. To find reasonable picks along this vein, I used Morningstar CPMS to rank the 703 companies in the Canadian database on several factors, including:
- Sector-relative price-to-earnings, price-to-cash-flow, price-to-sales and price-to-book ratios. (Each is a valuation metric comparing the company’s multiple against the median of the sector to which it belongs. In the table, for example, a figure of 0.9 implies that the company’s multiple is 10 per cent lower than that of the sector – lower figures preferred);
- annual dividend momentum (a short-term dividend growth metric comparing the last four quarters of dividends paid with the same figure one year ago).
To qualify, stocks must have a market capitalization great than $500-million, a figure meant to exclude the bottom one-half of stocks in the database by size. Additionally, only stocks with a positive reported return on equity (a quality metric) were considered. Finally, only companies with a dividend payout ratio against earnings of less than 80 per cent were included as a check to ensure dividends paid are reasonably sustainable.
What we found
I used Morningstar CPMS to back-test the strategy from May, 1992, to April, 2022, assuming an equally weighted 15 stock portfolio with no more than four stocks an 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, if any of the sector-relative valuation multiples exceeded 1.1 (signalling that the stock is 10-per-cent overvalued compared with sector peers), or if dividend momentum turned negative. 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 14.9 per cent, while the S&P/TSX Composite Total Return Index advanced 8.9 per cent. Today, only 11 companies meet the requirements to be purchased into the strategy. They are listed in the accompanying table.
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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