What are we looking for?
Canadian companies showing a near-term rise in earnings and positive price trends.
The screen
For momentum investors, quarterly earnings-per-share estimate revisions and quarterly reported earnings are of utmost importance.
Estimate revisions measure analysts' sentiment on a company's upcoming reporting period, while reported earnings show the actual result; that is, the bottom line of a company's quarterly results in shareholder terms.
Another key metric, earnings surprise, is the difference between the consensus estimate just prior to the company reporting, and the actual reported figure.
These three gauges are often viewed as main drivers of changes in a share price, as companies that grow their earnings and beat analyst expectations become favourable to investors.
This week, I focus on these metrics by looking to a modified version of the CPMS Earnings Momentum strategy that ranks companies on the best combination of these factors:
- Quarterly earnings momentum (which measures the latest four quarters of reported earnings against the same number one quarter earlier);
- Three-month earnings-per-share estimate revision;
- Earnings variability, which measures the volatility of a company’s reported earnings – a lower figure is better;
- Latest earnings surprise;
- Nine- and 12-month price changes.
Qualifying stocks have a market cap greater than $320-million, at least $1.4-million in volume traded in the past month and four active analysts covering the stock. Stocks with negative EPS estimates were also excluded.
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 June, 2015. During this process, 10 stocks were purchased and equally weighted with a maximum of three stocks per sector. Stocks would be sold if they fell outside the top 30 per cent of the ranked universe, or if estimates turned negative. Over this period, the strategy produced an annualized total return of 19.9 per cent while the S&P/TSX total return index gained 8.7 per cent. The top 10 stocks that qualify today are listed in the table.
As always, investors are advised to conduct their own independent research before purchasing stocks shown.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.