What are we looking for?
S&P 500 stocks growing faster than the index on a fundamental basis.
The screen
This week, I use Morningstar CPMS to create a strategy that focuses on stocks within the S&P 500 index that have exhibited consistent earnings over the past five years and have grown their sales and earnings figures faster than the median stock in the index.
The strategy ranks stocks using a combination of market capitalization and the five-year volatility of reported earnings per share (lower numbers are preferred for this latter figure).
To ensure that the stocks are indeed growing faster than the median, I've set the following limits:
- Three-year annualized sales growth must be greater than 4 per cent;
- Three-year annualized EPS growth must be greater than 7 per cent;
- Annual earnings momentum (latest four quarters of reported earnings versus the same figure four quarters ago) greater than 5 per cent.
The limits used in the above criteria represent the current median values for companies in the S&P 500.
In addition, to ensure stocks are not only growing, but are profitable, I've set a limit for the latest reported return on equity to be greater than 28 per cent, which represents the top one-third of stocks in the S&P 500 by this measure.
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, 1996, to August, 2016. During this process, 10 stocks were purchased and equally weighted with a maximum of three stocks a sector.
Stocks would be sold if they fell outside the top 40 per cent of the ranked universe, or if the growth metrics listed above deteriorated substantially relative to the median value in the index.
Over this period, the strategy produced an annualized total return of 10.7 per cent while the S&P 500 total return index advanced 7.6 per cent. The 10 stocks that qualify today are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.