What are we looking for?
Canadian momentum stocks.
It’s easy to pick two companies and compare them – for example, you can clearly see whether Stock A has the better dividend yield or Stock B has a better price-to-earnings ratio. But perhaps one of the most overlooked considerations is whether the two stocks you’re comparing are, in fact, comparable. If you’re shopping for a new TV, you’re not going to compare the newest Samsung TV with the latest iPhone, as that won’t give you much useful information when making your decision. The same theory can be used for stocks.
Today, I’m going to select a portfolio of Canadian momentum stocks based on how they relate to their industry peers. “Industry” refers to the Morningstar sector in which a stock is located and “peers” is shorthand for the median value of the other companies in the same sector. This strategy ranks stocks based on:
- Industry-relative annual earnings momentum – compares a company’s change in earnings per share (EPS) across the past year with its industry’s peers – higher values preferred;
- Industry-relative earnings surprise – compares by how much a company has exceeded/missed their latest quarter EPS expectations with that of its industry peers; higher values preferred;
- Industry-relative quarterly earnings momentum – compares a company’s change in quarterly EPS from the previous three months with that of the industry to which the company belongs – higher values preferred.
In order to qualify, stocks must have an industry-relative earnings surprise and an industry-relative quarterly earnings momentum greater than or equal to 1 per cent; a market capitalization greater than or equal to $250-million; and a five-year beta, relative to the S&P/TSX Composite Index, less than or equal to 1.1. (Beta measures a stock’s sensitivity relative to the index, lower values preferred.)
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 December, 1985, to May, 2019. During this process, a maximum of 10 stocks were purchased. Stocks were sold if their industry-relative earnings surprise or industry-relative quarterly earnings momentum fell below the industry by more than four percentage points. 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 14.8 per cent, while the S&P/TSX Composite Total Return Index returned 8 per cent over the same period.
Stocks that qualify for purchase into the strategy today are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed below.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.