What are we looking for?
Value stocks within the CPMS Canadian universe.
With stock valuations continuing to trend upward, a common question asked is whether there are still opportunities for value investors. Recall that value investing is a common strategy whereby investors search for stocks that are currently undervalued. The term “undervalued” can refer to both how it compares with other stocks (i.e. a stock that is undervalued relative to its peers), as well as relative to its own intrinsic value (defined as the value a stock is measured to be worth).
Today I’m showcasing a strategy that searches for Canadian value stocks out of the CPMS Canadian universe of stocks. This universe currently holds 693 names. The strategy ranks stocks based on: price-to-trailing earnings (measured as the company’s most recent share price divided by the previous four quarters' earnings per share, low values preferred); price-to-book-value (most recent share price divided by the book value per share, low values best); and price-to-trailing-cash-flow (most recent share price divided by the most recent four quarters of operating cash flow, low values best).
In order to qualify, stocks must have:
- An industry-relative trailing price-to-earnings ratio (calculated as a stock’s trailing P/E divided by the industry median trailing P/E, low values preferred) less than 1.1;
- An industry-relative price-to-book ratio (a stock’s P/B divided by the industry median P/B, low values preferred) less than 1.1;
- Average daily trading volume in the top half of peers, to avoid any highly illiquid stocks (today this value amounts to $490,000 or more in trading volume per day);
- Five-year beta (measures the sensitivity of a stock relative to an index – here we use the S&P/TSX Composite Index) must be less than one.
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.
What we found
I used Morningstar CPMS to back-test this strategy from June, 2002, to August, 2018. During this process, a maximum of 20 stocks were purchased. 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 12.2 per cent while the S&P/TSX Composite Total Return Index gained 8 per cent across the same period. Stocks that qualify for purchase into the strategy today are listed in the table below. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.