What are we looking for?
Large U.S. names showing good short-term earnings growth that have surprised analysts.
The screen
Year to date, the S&P 500 total return index is up roughly 8 per cent, in a continued bull run that spans back to the post-housing crises in the United States. Some investors feel the U.S. market may be fully valued, while others feel the economic outlook continues to be positive. Arguments can be made for both sides. This week, I use Morningstar CPMS to create a strategy that looks at the best combination of the following factors (considering both safety for the more bearish and growth for the bullish):
- Market cap (here larger companies are preferred as a safety factor. Generally speaking, in downturns, large companies tend to fair better than small companies);
- Quarterly earnings surprise (this compares the company’s latest report against the consensus estimate just prior to the company reporting);
- Quarterly earnings momentum (latest four quarters of reported earnings compared against the same figure one quarter ago).
To qualify, stocks must pay a dividend and must have reported positive EPS in the past quarter. Only two stocks per sector were considered in this analysis.
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, 1993, to April, 2017. During this process, a maximum of 22 stocks were purchased with a maximum of two per economic sector to ensure reasonable diversification. Stocks are sold if their rank falls below the top 25 per cent of the universe, or if the company reports negative earnings. 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 10.9 per cent while the S&P 500 total return index produced 9.4 per cent. Stocks that qualify for purchase into the strategy today are listed in the table below.
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.
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