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Inside the Market This simple TSX stock-picking technique has generated an average 18.4 per cent annual return over the past 16 years

The stock market can be a complex and intimidating place, but you don’t need an advanced degree to succeed at picking stocks because some of the simplest techniques have yielded the most generous returns.

One strategy is to seek profitable firms that trade at bargain prices. It’s an old value-investing technique that stretches back many decades in both the U.S. and Canada. I’ll apply it here in an effort to find large Canadian stocks trading at bargain-basement prices.

Before diving into the details, it’s useful to start with a suitable benchmark for large Canadian stocks. The S&P/TSX 60 index fits the bill. It tracks 60 of the largest firms in Canada and includes big banks, insurance companies, utilities, and resource firms among others.

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The S&P/TSX 60 index gained an average of 7.7-per-cent annually over the 16 years through to the end of 2017. It’s just the sort of result that inspires many to invest in low-cost index funds, which track the market. It’s a solid approach.

But I think it’s possible for more entrepreneurial investors to do better by concentrating on value stocks. There are several methods to do so but one of the simplest ways is to buy companies with lots of earnings when they trade at relatively low prices. That is, to buy stocks with low price-to-earnings ratios (P/E).

Bloomberg’s backtesting facility offers an easy way to find out how an investor would have fared by employing a simple low-P/E technique. In this case, buying an equal dollar amount of the 10 stocks with the lowest price-to-earnings ratios in the S&P/TSX 60 index each year. The stocks are held for a year, sold and the money moved into the 10 stocks with the lowest ratios in the following year, and so on.

The low-P/E portfolio would have gained an average of 18.4-per-cent annually over the 16 years through to the end of 2017. It beat the index by a whopping 10.7 percentage points per year on average. (All of the return figures mentioned herein include reinvested dividends. They do not include fund fees, taxes, commissions, or other trading frictions.)

You can examine the annual return history of the 10-stock low-P/E method in the accompanying bar chart. Note that its worst showing came during the crash of 2008 when it fell 43 per cent. But the method quickly recovered with a huge 170-per-cent gain in 2009.

One might be concerned that the two extreme returns (both positive and negative) overly influenced the results. If one removes them, the low-P/E portfolio would have gained an average of 17.6-per-cent annually over the remaining 14 years. As a result, the method doesn’t appear to be overly influenced by its most extreme periods.

The low-P/E portfolio lost money on two other occasions during the 16-year period with a decline of 11 per cent in 2015 and a slip of well less than 1 per cent in 2011. On the other hand, it gained in 13 of the 16 years and climbed by more than 14 per cent in five of the last six years. Not bad for what is admittedly a very simple approach to picking large Canadian stocks.

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In an effort to extend the backtest to a period before the creation of the S&P/TSX 60 index, I tested a strategy of picking the 10 stocks with the lowest P/Es each year from the largest 60 stocks in Canada by revenue. This similar low-P/E portfolio gained an average of 17.4 per cent over the 16 years to the end of 2017 and an average of 17.5 per cent over the 20 years through to the end of 2017.

While it’s impossible to guarantee that the good times will continue, you can find the current crop of low-P/E darlings in the accompanying table. For what it’s worth, I happen to hold many of them myself.

But no approach is perfect. I fully expect the low-P/E portfolio to lag from time to time and it may not perform as well in the future. But I think the odds are good that it will fare reasonably well over the long term.


Low P/E Darlings

Portfolio of 10 stocks with the lowest P/E ratios in the S&P/TSX 60 

CompanyTickerPrice ($) P/EYield
Metro Inc.MRU-T42.485.61.7%
Cenovus Energy CVE-T13.476.01.5%
Teck Resources TECK.B-T34.077.40.6%
Power Corp Of Canada POW-T29.899.05.1%
Canadian Imperial Bank of CommerceCM-T113.1810.34.7%
Magna International MG-T82.5010.42.1%
National Bank of Canada NA-T61.6210.93.9%
Kinross GoldK-T4.6410.90.0%
Bank of Nova ScotiaBNS-T76.9511.24.3%
Royal Bank of CanadaRY-T96.8812.43.9%

Source: Bloomberg (Data as of May 29, 2018)

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.

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