What are we looking for?
Consistently profitable TSX stocks on a tear.
Even for seasoned investors, buying a stock near its 12-month high can often be counterintuitive. However, the momentum-driven Canadian market often rewards those who do so. To confirm this, I used Morningstar CPMS to look at what would happen if an investor were to own only the 50 stocks in the S&P/TSX Composite Index trading closest to their 12-month high at a given point in time, refreshing the portfolio every month. The result showed me that over the trailing 35 years a theoretical investment in this manner would have beaten the index by 3.8 per cent annualized. That said, the test also showed that the portfolio had a turnover ratio of close to 500 per cent, which would be impractical for an investor to manage realistically – not to mention the exorbitant trading costs that can be detrimental to returns. Moreover, the strategy was essentially a roller coaster, and rife with volatility.
Building on this, I coupled the idea with profitability metrics and sector limits to understand whether we could derive a more reasonable strategy. To start with, I ranked the 229 companies in the S&P/TSX Composite Total Return Index on the following metrics:
- Price from 12-month high (A figure of minus 0.1 per cent, for example, would signal that the stock’s price is 0.1 per cent lower than its 12-month high. Here we prefer those that are less negative, meaning those very close to their high);
- Five-year average return on equity (a profitability metric, higher figures preferred);
- Five-year deviation of return on equity (a measure of volatility, lower figures preferred, implying that return on equity has been consistent over the past five years).
Only stocks from the S&P/TSX Composite Total Return Index were considered.
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
I used Morningstar CPMS to back-test the strategy from December, 1990, to August, 2021, assuming a 15-stock portfolio that holds no more than three stocks per economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, keeping in mind the aforementioned sector limits. On this basis, the strategy produced an annualized total return of 12.2 per cent, while the S&P/TSX Composite Total Return Index advanced 8.9 per cent.
The strategy turnover was 79 per cent, implying that roughly 12 of the 15 stocks were bought and sold each year, on average. 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. It is always recommended to speak with a financial adviser or professional before investing.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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