What are we looking for?
Canadian stocks with a momentum tilt.
Momentum investing continues to be top of mind right now, especially given the strategy has been in favour this year compared with value and dividend investing. While this style of investing has always been enticing given the high returns typically associated with it, many investors may avoid or limit their use of the strategy because of the higher volatility that is also usually present.
Today, I’m showcasing a strategy that looks for Canadian momentum stocks within the CPMS Canadian universe (today consisting of 701 names) without taking on excessive risk. Stocks are ranked based on quarterly earnings surprise (proprietary measure of the difference between actual and expected quarterly earnings – higher value is best); quarterly earnings momentum (measured as the growth in the most recent trailing four quarters earnings relative to the trailing four quarters’ earnings lagged by one quarter – higher value is best); and a stock’s price change from its 12-month high (a momentum factor – least-negative value is best). In order to qualify, stocks must have:
- Quarterly earnings momentum greater than zero;
- Quarterly earnings surprise greater than zero;
- Price change relative to 200-day moving average greater than 3 per cent (a technical indicator);
- Five-year beta less than or equal to one in order to limit overall market sensitivity. (Recall that beta measures a company’s sensitivity relative to historical changes in the benchmark – here, we use the S&P/TSX Composite Index; in trending markets, a stock with beta less than one has historically moved less than the index.)
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 110 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 February, 1999, to May, 2018. During this process, a maximum of 20 stocks were purchased. Stocks were sold if their price change relative to 200-day moving average fell below minus 15 per cent. 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 24.7 per cent while the S&P/TSX Composite Total Return Index advanced 7.6 per cent across the same period. One thing worth noting is that the strategy’s downside deviation (measures the volatility of negative returns) was 7.7 per cent relative to the benchmark’s downside deviation of 9.4 per cent.
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 here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.