What are we looking for?
Canadian companies growing at a reasonable price.
The screen
This week, I use Morningstar CPMS to create a GARP (growth at a reasonable price) strategy with a tilt toward quality and low volatility for investors who prefer not to deal with the roller coaster that often comes with short-term growth. The strategy ranks stocks on:
• Forward PEG ratio (a classic GARP metric that compares the forward price-to-earnings ratio with the forward growth rate of earnings. This answers the question: Am I paying too much for growth? Lower figures preferred);
• Three-year and five-year historical beta (recall that a stock with a beta of less than one historically has moved less than the index in trending markets. Here we prefer companies with lower beta);
• Five-year earnings-per-share growth rate (a measure of how much EPS has grown on average a year over the past five years);
• Five-year and 10-year average return on equity (recall that ROE is a profitability measure – here we look over a longer history with higher figures preferred).
To qualify, companies must have at least three active analysts covering the stock, and a debt-to-equity ratio equal to or lower than that of the sector median to avoid overly leveraged companies. Companies with market cap less than $330-million were also excluded (this figure represents the median market cap in the CPMS Canadian Universe, which today consists of 710 companies).
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 Morningstar CPMS to back-test this strategy from December, 1995, to June, 2017. During this process, a maximum of 15 stocks were purchased with a maximum of four an economic sector to ensure reasonable diversification. Stocks were sold if their rank fell below the top 35 per cent of the universe. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 14.5 per cent while the S&P/TSX composite total return index advanced 8.1 per cent. Today, only 13 stocks qualify for purchase into the strategy and they 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.