Craig McGee is a senior consultant at Morningstar Canada.
What we are looking for
The health care sector has led the way in the United States so far this year. Over the 12 months ended Aug. 31, the S&P 500 Health Care sector has returned 32 per cent, while the broader index has returned 25 per cent. Following this trend, we wanted to look for stocks in the sector that could continue to outperform.
The screen
Analyzing the CPMS historical U.S. database back to 1993, we selected a number of attributes that have helped to drive more consistent performance from health care stocks. Specifically, I scanned the CPMS U.S. database for the 20 health care stocks with the best combination of the following metrics:
- earnings yield (trailing four quarters' earnings as a percentage of the latest price);
- cash flow yield (trailing four quarters' cash flow as a percentage of the latest price);
- sales yield (trailing four quarters' sales as a percentage of the latest price);
- quarterly earnings momentum (QEM); that is, the percentage change in the latest four quarters' earnings per share compared with the four quarters' EPS of one quarter ago;
- expected quarterly earnings momentum for next quarter (QEM Next);
- revision of the consensus EPS estimate over the past three months.
A minimum market cap of $500-million was also used.
More about Morningstar
Morningstar 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
Using CPMS's historical database, we back-tested the strategy to apply the same rules-based approach starting Dec. 31, 1993. A portfolio of up to 20 stocks was equally weighted, and stocks would be replaced if their rank fell outside of the top 40 per cent of all health care stocks.
Over the past year, this strategy generated a total return of 41.9 per cent, outpacing both the health care sector and the S&P 500. For the full period starting Dec. 31, 1993, this approach would have posted an annualized return of 22.2 per cent versus 12.7 per cent for the health care subindex and 9.4 per cent for the S&P 500.