What are we looking for?
Balancing value, stability and growth in the S&P/TSX composite index.
The screen
At the time of this writing, the S&P/TSX composite is up a whopping 19.5 per cent year to date, powered largely by commodity and energy prices. For those not buying into this momentum market, this week's strategy may be an alternate for a longer-term investment strategy that balances value, growth and stability within the S&P/TSX composite index. The strategy ranks stocks on the best combination of:
- Five-year historical beta (recall that beta measures a stock’s historical sensitivity to a benchmark. A stock with a beta less than 1 has historically moved less than the benchmark in trending markets, while a stock with beta greater than 1 will move more than the benchmark. Here, lower betas are preferred);
- Earnings variability (a measure of how consistent a company’s reported earnings have been historically. Lower figures are preferred here);
- Price-to-earnings, price-to-sales and price-to-book ratios (in all cases low valuations are preferred);
- Trailing return on equity;
- Expected EPS (earnings per share) growth rate (calculated as the median EPS estimate for a company’s current fiscal year as a percentage change from the median EPS estimate from the previous fiscal year).
To qualify, a stock must be part of the S&P/TSX composite 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 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, 1991, to October, 2016. During this process, a maximum of 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 50 per cent of the ranked universe, or if the consensus estimates dropped by more than 10 per cent over a three-month time frame. Over this period, the strategy produced an annualized total return of 14.9 per cent while the S&P/TSX composite total return index produced 8.5 per cent. From the start of 2016 to the end of October, the strategy produced a respectable 7.6-per-cent gain, while the S&P/TSX produced 16.5 per cent, again keeping in mind this strategy tends to steer clear of the more volatile commodity and energy stocks. The top 20 stocks that qualify for purchase today are listed in the table below.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.