What are we looking for?
Stocks to avoid or at least be careful with.
More about today's screen
We'll ask Morningstar CPMS for help today in identifying stocks that are falling and have potential to fall further. CPMS calls these stocks "potential falling knives."
Jamie Hynes, senior consultant at CPMS, says there are three key fundamentals that help determine whether a stock will keep falling: earnings estimates have fallen in the past three months, quarter-over-quarter earnings are falling and earnings surprises are negative.
The stocks today show the worst ratings in the three key fundamentals compared to the other Canadian stocks in its database (A is best, E is worst). The list today is sorted by worst total return year to date.
More about CPMS
CPMS is a Toronto-based equity research and portfolio analysis firm owned by Morningstar Canada. It maintains a database of about 680 of the largest and more liquid Canadian stocks, plus another 2,100 U.S. stocks, and spends a lot of time adjusting for unusual accounting items in each company's quarterly results to make sure screens can perform correctly.
What did we find out?
Mr. Hynes tested the falling knives portfolio going back to 1991 and found that it returned just 1.7 per cent annually, versus 9.7 per cent for the S&P/TSX total return index (transaction costs not included, portfolio rebalanced monthly, each stock given equal weight in the portfolio).
The portfolio posted a negative return in 15 of 19 years.
Value investors may be tempted to start investigating some of these stocks (the falling knives actually rose 71 per cent in 2009 with the market rebound), but it might be better to watch these names for improving fundamentals first. Price to estimated earnings, price to book value per share and average analyst rating (5 is strong buy, 1 is sell) is also shown in the columns so that value investors can get a sense of how cheap they are now.
"There may be some real bargains amongst these names, but as a general rule, extreme caution is required when trying to catch falling knives," Mr. Hynes said.