What are we looking for?
Potentially undervalued Canadian companies with momentum and earnings to reinvest.
The screen
Resources and commodities have been rebounding and the Canadian market has been trending upward as a result. Since Jan. 20, the S&P/TSX composite index has risen 12 per cent. To identify reasonably valued companies with room to grow, my colleague Lawrence Ullman and I looked to the EMG (enterprise multiple to growth) ratio. Similar to the PEG ratio (price-earnings to growth), the EMG ratio compares valuations with growth levels by taking EV/EBITDA (total enterprise value divided by four quarters of earnings before interest, taxes, depreciation and amortization) and dividing by the sustainable growth rate to take growth prospects into account. We used Morningstar CPMS to find the top 10 Canadian stocks with the best mix of:
- EMG ratio (lower is better);
- Three-month consensus earnings estimate revision (cannot be negative);
- Latest earnings surprise (cannot be negative);
- Three- and 12-month price change
EMG values must be less than the database median, market cap must be above $200-million, average trading volume must be greater than the database median and three-month price change cannot be negative.
More about the Ullman Group
The Ullman Group is an independent provider of strategic private capital management services to high net worth individuals, corporations, endowments, charities and foundations.
What we found
We used CPMS to perform a back-test starting Feb. 29, 2006, selecting an equally weighted portfolio of the top 10 qualifying stocks. Universe rankings were recalculated monthly and holdings would be replaced if their rank fell outside of the top 40 per cent or if consensus estimates or price fell more than 15 per cent over three months. Over the 10-year period, this strategy would have generated an annualized total return of 14.2 per cent compared with 3.9 per cent for the S&P/TSX composite total return index. Following the strategy over the past year would have resulted in a gain of 1.9 per cent compared with a loss of 12.9 per cent for the index.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.
Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.
Richardson GMP Ltd. is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities LP. Both used under licence by Richardson GMP Ltd.