What are we looking for?
Canadian companies investing for future growth – and winning.
Investors who have been rewarded over the past year for good picks in the Canadian equity markets will recognize names such as Valeant Pharmaceuticals International Inc., Dollarama Inc. and Alimentation Couche-Tard Inc. These companies have consistently shown positive price momentum over the multiple time periods over the past year. One common trait amongst these companies is the fact that they have high reinvestment rates.
The reinvestment rate is a measure of earnings per share less dividends as a percentage of the company's adjusted book value per share and is a measure of a company's ability to invest for future growth.
The screen
It is no surprise that the names above also show up as top picks in the CPMS Canadian Asset Growth Strategy, which is our best performing strategy year to date. This week I look at a modified version of this strategy and rank stocks based on the best combination of the following factors:
- forward and trailing reinvestment rates;
- three-month estimate revisions (current consensus estimate for earnings per share versus three months ago);
- earnings surprise (difference between the latest reported earnings and the estimate);
- quarterly sales momentum (trailing four quarters of sales compared with the same number, one quarter ago).
Only the largest 250 stocks in Canada by market capitalization were considered.
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 CPMS to back-test the strategy from December, 1993, to June, 2015. During this process, 20 stocks were purchased and equally weighted with a maximum of five stocks a sector. Stocks would be sold if they fell outside the top 40 per cent of the ranked universe or if the three-month estimate revision dropped more than 10 per cent.
Over this period the strategy produced an annualized total return of 14.4 per cent while the S&P/TSX total return index produced 8.2 per cent. In the trailing 12-month period, the strategy produced an annualized total return of 21.4 per cent return while the S&P/TSX total return index lost 1.2 per cent. The top 20 qualifying stocks are listed in the table.
As always, investors are advised to conduct their own independent research before purchasing shares in the companies shown.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.