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What are we looking for?

S&P 500 stocks showing value relative to their sector peers.

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Though it is true that growth stocks have far outperformed value over the past decade, recent events have seen growth-oriented names get hammered alongside recent market volatility surrounding the Russia/Ukraine conflict. For investors who feel that now may be an opportunity to find some good deals, today’s strategy offers some reasonable ideas. I started with ranking the stocks in the S&P 500 index on the following metrics:

  • Five-year standard deviation of earnings (a statistical measure of volatility, in this case of bottom line earnings over the last five – lower figures preferred);
  • five-year price beta (recall that beta measures the historical sensitivity of a stock relative to an index. A stock with a beta of 1.0 has historically moved in tandem with an index in trending markets – here we prefer stocks with lower betas);
  • sector-relative price-to-cash-flow, price-to-trailing-earnings, and price-to-sales multiples (here, a figure of 0.9 implies that the stock’s multiple is 10 per cent lower than that of the sector to which it belongs);
  • enterprise value/EBITDA (another valuation metric that considers both debt and equity in the numerator, and a gross earnings in the denominator – lower figures preferred).

EBITDA stands for earnings before interest, taxes, depreciation and amortization. To qualify, stocks must have either:

  • At least one of the sector-relative multiples less than 1.0, implying that, on at least one basis, the stock is trading at a discount to peers;
  • or an EV/EBITDA ratio of less than 14, a figure that represents the median of the S&P 500 index today.

More about Morningstar

Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.

What we found

S&P 500 stocks

RankCompanyTickerMorningstar SectorMkt. Cap. ($ Mil.)5Y EPS Dev. (%)5Y Hist. BetaSector Rel. P/CFSector Rel. P/ESector Rel. P/SEV/EBITDA5Y Avg. ROE (%)Div. Yld. (%)12M Ttl. Rtn. (%)Recent Close (US$)
1Cardinal Health Inc.CAH-NHealth care14,526.
2AmerisourceBergenABC-NHealth care30,
3Walgreens BootsWBA-QHealth care40,979.511.
4Verizon Comm.VZ-NComm. Services223,534.
5Consol. EdisonED-NUtilities31,425.
6AT&T Inc.T-NComm. Services164,
7Intel Corp.INTC-QTechnology193,420.
8Amgen Inc.AMGN-QHealth care128,729.
9Kroger Co.KR-NCons. Defensive40,445.511.
10Duke EnergyDUK-NUtilities81,
11Xcel Energy Inc.XEL-QUtilities38,
12Eversource EnergyES-NUtilities29,308.
13Leidos HoldingsLDOS-NTechnology14,359.
14Kellogg Co.K-NCons. Defensive21,
15HP Inc.*HPQ-NTechnology37,531.412.

Source: Morningstar CPMS; data as of March 8

*Note that HPQ looks to have an exhorbitantly high average ROE owing to the very low or negative book value of equity. This extreme value was accounted for in the ranking process.

I used Morningstar CPMS to back-test the strategy from April, 2004, to February, 2022, assuming an equally weighted 15-stock portfolio with no more than four stocks per economic sector. During this process, stocks were monitored monthly and sold if they fell below the top quartile of the index based on the above metrics, or if they exceeded all the aforementioned valuation ratios. On this basis, the strategy produced an annualized total return of 11.8 per cent, while the S&P 500 Total Return Index advanced 10.2 per cent. In the trailing 12 months ended Feb. 28, the strategy produced 24.2 per cent while the index rose 16.4 per cent. The stocks that meet requirements to be purchased into the strategy today 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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