What are we looking for?
U.S. companies with strong sales.
This week, skittish investors are likely glued to their Twitter feeds as the U.S. President’s tweets add to market worries over increased trade tensions with China. An escalating trade dispute would certainly put a damper on most companies’ revenues. This week, I look for companies that have a strong revenue stream to begin with, perhaps allowing them to withstand the impact of potentially aggressive tariffs from the world’s two largest economies. To find these companies, I rank the stocks in the S&P 500 on the following factors:
-Quarterly sales momentum (latest four quarters of revenues compared with the same figure one quarter ago);
-Sector-relative price-to-sales (a value metric comparing the company’s P/S ratio against the median sector – lower values preferred to ensure we aren’t overpaying for sales);
-Historical-relative price-to-sales (comparing the P/S ratio against the stock’s own historical median over the past 10 years).
(In the table, a sector-relative P/S ratio of 0.3, for example, would imply that the stock’s P/S is 70 per cent lower than that of the sector to which it belongs. In the case of historical-relative P/S, 0.3 would imply it is 70 per cent lower than the company’s own 10-year historical median.)
To qualify, a company must have a sales-to-total-assets ratio greater than 0.5 times to ensure it has enough sales to cover its debt; 0.5 represents the median sales-to-total-assets ratio for the S&P 500 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 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 April, 2004, to April, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four per economic sector. Once a month, stocks were sold if their rank fell below the top 35 per cent of the ranked universe. 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 15.1 per cent while the S&P 500 Total Return Index gained 9 per cent.
The stocks that qualify for purchase today and are listed in the accompanying table. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.