Meet the Megastars
Don't have time to crunch the Top 1000 data yourself? This year, we've done the hard work for you, selecting the 20 best stocks to buy now, based on value, momentum and quality.
The Top 1000 rankings in ROB Magazine and on this website only provide a limited snapshot of data for the top 1000 companies in Canada. The most comprehensive database of Canadian corporate financial information is available for purchase in spreadsheet format here. Find in-depth financial and contact information, total compensation for every CEO on the Top 1000 and more.
If it weren't for the Top 1000, Report on Business magazine might not exist. Canada's largest and most authoritative corporate ranking first made its appearance in the inaugural issue of the magazine, way back in 1984.
The list debuted the same year the Apple Macintosh did—personal computers were just starting to catch on—but the Internet wouldn't start connecting home computers for another decade. Back then, when investors wanted to know how much revenue the Bank of Montreal made in its last fiscal year, they wouldn't Google it, they'd flip open a copy of Report on Business magazine and look it up.
More than 30 years later, it won't shock you to hear that there are fewer people turning to print magazines for investing data—the web is obviously the place to go. So, in an effort to keep the Top 1000 useful and relevant, we've decided to make a few changes.
For starters, we have decided to list only the top 250 companies in print. Subscribers can find the full list online at tgam.ca/top1000, which is probably the best place to peruse our data anyway. Accordingly, we've made big improvements to the online table to make it easier to use: It is now fully responsive (so it works on mobile); you can sort the data by profit, revenue and a variety of other metrics; it's searchable; and it even includes a new real-time stock price lookup feature.
Another change we've made this year is ranking the companies by revenues rather than profits. This is mainly because revenues are more stable than profits, which can vary due to one-time write-downs, asset sales and other unusual events. It also happens to be the default ranking criterion used by most of the big lists in the U.S., such as the Fortune 500.
The third change we've made is the most exciting of all: This year, in addition to presenting all of the raw data, we're introducing a new stock rating system that does a lot of the number crunching for you, narrowing down the field to the stocks that offer the most promising opportunities.
To that end, each of the top 250 stocks by revenue is graded on a five-star scale based on a suite of measures of investment merit. Time-tested techniques are used, along with some heavy-duty math, to distill everything down into an easy-to-use star ranking. Stocks with the most stars are deemed to have the best shot at doing well over the next year.
The star system merges two schools of investing. Value investing techniques are employed to zero in on profitable companies trading at low prices. We then apply techniques favoured by momentum investors. Both are buttressed by measures of quality in an effort to avoid overly fragile businesses.
This sophisticated system is based entirely on the numbers. More qualitative aspects of a company don't enter into it. As a result, the number of stars a stock gets does not reflect the character of a company or its management. It is entirely possible that an outstanding company with able managers will get a low rating when it trades at a very high price. Similarly, a low price can make a less-than-outstanding business an attractive investment.
Over all, we think the new system offers a sane and objective take on the Canadian stock market, and we hope you'll find this year's ranking useful. You can peruse the
star ratings in the last column of the Top 1000 tables that follow. We've also included a separate table highlighting the 20 Megastar Stocks that achieved the full five-star rating on page 41. Here's how we awarded the stars.
Hunting For Value
Traditionally, the Top 1000 was sorted by profit. While we decided to highlight the largest companies by revenue this year, we're still big fans of looking at the bottom line. That's why the search for bargain stocks starts with each company's price-to-earnings ratio, and we favour profitable firms trading at comparably low prices.
Sticking to stocks with low price-to-earnings ratios is a classic value investing technique. James O'Shaughnessy studied it for the fourth edition of his influential book What Works on Wall Street. He reported that U.S. stocks with the lowest 10% of price-to-earnings ratios gained 16.25% annually from the start of 1964 through to the end of 2009. By way of comparison, the average stock gained 11.22% annually over the same period.
We don't stop our search for value with just one ratio. We are also keen on stocks trading at low prices in comparison to their revenues. On the other hand, we shy away from companies that have yet to generate revenues and those that trade at very high price-to-sales ratios.
We also take into consideration companies' cash flows by seeking out those with low price-to-cash-flow ratios. It's good to see a company's earnings translate into cold, hard cash.
Speaking of cash, we appreciate firms that pay generous dividend yields, because we like to be paid to take on the risk of stock ownership. We also approve of firms that reduce their share counts by buying back stock. We combine both factors to gauge how much money a firm is returning to shareholders.
Moving With Momentum
Momentum investors love to buy stocks on the upswing, with the expectation they'll continue to climb higher. As an important corollary, stocks on the decline tend to continue to slide, at least in the short term.
While it might seem to be overly simplistic, buying based on momentum has been profitable in nearly every stock market in the world for decades, and it has worked well with many other asset classes. Momentum has the hallmarks of being a core feature of capital markets.
For instance, O'Shaughnessy reports that the 10% of U.S. stocks that performed the best over the prior six months went on to generate average annual returns of 14.11% based on data from the start of 1927 through to the end of 2009. The average stock climbed at an annual rate of just 10.46% over the same period.
We take a blended approach when it comes to momentum and combine the results from several different periods over the last year. We favour stocks that have performed well compared to their peers over the last three, six, nine and 12 months, because such stocks are likely to do well over the following several months.
The Quest For Quality
Quality can be a slippery concept when it comes to stocks, because the market does a reasonably good job of pricing in many of its outward signs. It's a big reason why our approach to quality aims mainly to reduce risk rather than to enhance reward.
To start, we appreciate companies with solid returns on equity that have managed to deploy their capital wisely. It is also useful to look for a pattern of growth and to seek out firms that have grown their earnings-per-share at a reasonable rate over the past year.
On the other hand, caution should be taken with firms that industry analysts believe will have negative earnings over the next 12 months. Analysts tend to be an overly optimistic bunch. If they think a company will lose money, then the situation is probably pretty grim.
The last quality indicator is a technical one. Highly volatile stocks are penalized while firms with steadier return patterns are given a boost—we believe more speculative stocks should generally be avoided.
A Question Of Equity
The Top 1000 follows a wide variety of companies, from the very large to the very small. Problem is, our star system runs into trouble dealing with all of them in a fair way. For instance, penny stocks can experience percentage price swings that cause trouble for momentum-based approaches. Similarly, junior resource firms that have yet to earn a cent in profit don't stand a chance of passing the value test.
We use several factors to deal with such cases. Stocks are set aside when they have less than a year's worth of trading history or have traded for less than $2 per share over the same period.
We also exclude stocks with very high price-to-sales ratios, those with tiny market capitalizations (or revenues), those lacking common shares on the TSX, and those subject to takeover offers. Such firms aren't rated in the tables
that follow. But we hope they'll be up for five-star consideration next time.
The Five-Star Stocks
You might be wondering how any stock can pass all of our tests, but in our system everything is relative. We focus on how well they do in comparison to their peers. Only 20 of the largest 250 stocks by revenue were awarded five stars this year, and they are listed alphabetically in the "Megastar Stocks" table above. We also provide ratings for many of the smaller stocks in the online version of the Top 1000 table, which can be found at tgam.ca/top1000.
Before discussing the Megastar Stocks, it is important to know that the ranking process can pick up a large number of stocks from select industries that happen to be on the upswing. Prudent investors who want to diversify their portfolios across industries should dole out their money appropriately.
This year, the five-star list favoured stocks from two broadly defined industries. Forestry got top billing—despite recent political pressure from the U.S.—and transportation-related companies fared quite well too.
West Fraser Timber (WFT) is the largest of the five forestry firms in the five-star list by both market capitalization and revenues. Canfor Corp. (CFP) follows close behind, and brings with it Canfor Pulp Products (CFX), its smaller subsidiary. Norbord (OSB) and Interfor (IFP) round out the group. On their merits, Canfor Corp. and West Fraser Timber lead the group, by a hair.
While forest product stocks have done well in recent times, they tend to be somewhat cyclical. Softness in the economy, or negative developments on the international trade front, could cause their shareholders consternation. Unfortunately, the threat of the latter looms large with the pending renegotiation of the North American Free Trade Agreement. It's something that poses a risk to many Canadian businesses—and more than a few American ones as well.
The five-star representatives of the transportation group are divided between land and air. In the skies, Air Canada (AC) got the nod after chalking up a 72% return over the past year. Chorus Aviation (CHR), which runs some of Air Canada's routes, made the grade with a 6.6% dividend yield. Magellan Aerospace (MAL) supplies components and parts to the industry and can be had for 11.8 times earnings. On the ground, auto-parts makers Linamar (LNR), Magna (MG) and Martinrea (MRE) all got top marks. BRP Inc. (DOO) put its Ski-Doos into overdrive and zoomed ahead to gain 71% over the last 12 months.
Highly rated gas utilities include Capital Power (CPX) and Just Energy (JE), with both paying dividend yields of 6.5%. Continuing the energy theme, oil producer Paramount Resources (POU) got the star treatment thanks to a gusher-like gain of 191% over the past year.
Transcontinental (TCL.A) does well enough to pay a 4.1% dividend yield in the not-so-glamorous world of printing and publishing. But if you don't like publishing, then Cascades (CAS) provides a nice package at just 8.5 times earnings. Those looking to unbox gold this summer can get a bargain from Centerra Gold (CG) at 7.9 times earnings. If electronic gadgets are more your thing, then Celestica (CLS) charged up a 51% return over the last 12 months. Last on the five-star list is insurance conglomerate E-L Financial (ELF), which trades at a sharp discount to its net asset value.
Use the Top 1000 as a starting point for further research. While we expect that our ranking will produce solid results over time, we can't say that loading up on every five-star stock will automatically lead to riches. The market simply isn't that predictable. But we do think the five-star stocks have the ingredients needed for success and they deserve your attention. On the other hand, care should be taken when dealing with stocks with less than two stars.
It is important to be mindful of the built-in limitations of quantitative methods like ours, because less tangible factors can be important when investing. For instance, the quality of a company's management can help or hinder a business. Get up to speed on any recent developments, and read the firm's latest press releases and regulatory filings.
Use the following data in whichever way means the most to you. After all, the purpose of our new system is to guide you through a constellation of data to a few stars that deserve your consideration.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com. He holds shares of Magna, E-L Financial and other stocks on this list.