What are we looking for?
TSX-listed stocks that combine momentum and fundamental earnings quality.
As of Tuesday’s close, the S&P/TSX Composite Total Return Index has shown a year-to-date return of 20.1 per cent, recently outpacing its own 50- and 200-day moving averages. For investors keen on following momentum, there are likely many names to choose from at this time. That said, a search for momentum without quality can often be a risky approach, as investors rely largely on market sentiment without a sound footing on the fundamental nature of a company’s financials. This week, I use Morningstar CPMS to create a model that looks for companies that show reasonable fundamental quality and have recently outperformed their respective sectors and the market as a whole. To do this, I ranked the largest 250 companies in Canada by size on the following factors:
- Price change from month-end three months ago – on an absolute basis, relative to the stock’s sector, and relative to the S&P/TSX Composite Index;
- Five-year deviation of earnings (a quality metric measuring how steady operating earnings have been over the past five years, lower figures preferred);
- Five-year average return on equity.
To qualify, companies must have a reported positive trailing four quarters of operating earnings and must have a positive earnings-per-share estimate for the current fiscal year not fully reported. Unit trusts were excluded in this analysis.
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 May, 1992, to August, 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 50 per cent of the universe, if the company reported negative earnings or if analyst consensus EPS estimates turned negative. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 12.3 per cent while the S&P/TSX Composite Total Return Index advanced 8.6 per cent.
The stocks that qualify for purchase today 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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