What are we looking for?
Canada's benchmark stock index has soared more than 70 per cent from its lows of March, 2009. While that's great news for investors whose portfolios have surged in value, it's made the job of investing new money more difficult.
"The pool of cheaply valued stocks is becoming harder to find given the strength of the recent rally," Myles Zyblock, chief institutional strategist and director of capital markets research with RBC Dominion Securities, said in a recent note.
Not to worry. Mr. Zyblock and his team came up with a list of stocks that they believe still offer good value, despite the market's big gains.
Dodging the value trap
To find inexpensive stocks, they screened for companies that trade at low price-to-earnings ratios. The P/E is the price of the stock divided by the earnings per share over the previous 12 months. For example, a company whose stock is trading at $20 and which generated $2 a share in earnings has a P/E of $20/$2 or 10.
The lower the P/E, the less the investor is paying for the company's earnings.
Focusing on P/E exclusively, however, is asking for trouble. In some cases, a low P/E can signal that a company has poor growth prospects or may be in financial trouble. These stocks are known as value traps - they look cheap on the surface, but they get even cheaper as the company's outlook worsens.
To minimize that risk, Mr. Zyblock looked for stocks that also scored well on two other indicators - price momentum and earnings predictability. If a stock has been rising steadily and has a fairly predictable earnings stream, this "greatly reduces the odds of buying into a classic value trap," he said.
The stocks in the screen received a grade of 1 to 10 on each measure, corresponding to the "decile" ranking. A grade of 1 meant the stock scored in the top 10 per cent (or decile) on that measure, a 2 corresponded to the second 10 per cent, and so on. The lower the grade, the higher the stock's ranking.
The results
Most of the 18 stocks on the list are well-known Canadian companies with strong earnings and solid dividends. However, remember to do your own research before buying any security. Also be mindful of any change in the company's circumstances since RBC Dominion Securities Inc. performed the screen on Oct. 15.
For example, Rogers Communications' shares plunged after it released weaker-than-expected quarterly results last month, proving that a low P/E, strong momentum and predictable earnings are no guarantee that a stock won't fall.