What are we looking for?
Companies flying under the radar of institutional analysts.
The screen
Canadian institutional investors often rely on top-tier analysts from Canada's broker-dealer network to provide in-depth research on potential stock investments. Analysts are key part of the financial ecosystem as they provide estimates that guide investors on key measures, such as the expected earnings of a company in an upcoming reporting period.
For many reasons, the coverage universe of analysts often skew toward larger-cap names that are highly liquid and widely held by institutions (which often have market cap limitations imposed on the investments they can hold). This leaves a number of stocks that can fly under the radar. In this week's strategy I look for thinly covered stocks that also rank well on the following factors:
- Five-year earnings per share growth
- Five-year sales growth
- Five-year average return on equity
- Annual pretax return on capital (the ratio of pretax earnings to debt plus equity).
Qualifying stocks have only one (or no) analyst with active estimates in the CPMS database and a debt-to-equity ratio less than 1.0 times to ensure companies aren't over leveraged. Stocks with less than $100,000 in average daily trading volume (measured over three months) were 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 November, 2001, to June, 2015. During this process, 10 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 50 per cent of the ranked universe. Over this period the strategy produced an annualized total return of 18.1 per cent, while the S&P/TSX total return index gained 7.8 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. It is also worthwhile to note that investors wishing to enter into positions in these companies will need to accommodate for liquidity constraints associated with investing in small-cap stocks.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.