What are we looking for?
Stocks that combine growth and stability.
The screen
Despite uncertainty with the North American free-trade agreement and issues on the home front such as the effect of interest rates on high household debt, the S&P/TSX composite total return index seems to be faring reasonably well. Although nowhere near the monstrous 20-per-cent-plus returns achieved in 2016 driven largely by energy and commodity prices, the S&P/TSX composite total return index is up 6.4 per cent year to date. Cautious investors who believe companies will continue to grow in this environment but don't want to be met with substantial volatility can look to the following strategy for some ideas.
Using Morningstar CPMS I ranked the largest 250 companies in Canada, excluding real estate investment trusts, based on:
- Quarterly earnings momentum (a growth factor comparing the latest four quarters of operating earnings with the same figure one quarter ago);
- Five-year historical beta (a safety factor, measuring how sensitive a stock is historically to our main benchmark, the S&P/TSX composite total return index. Recall that a stock with a beta less than one has historically moved less than the index in trending markets. Here, stocks with lower beta are preferred).
To qualify, companies must have a market capitalization greater than $1-billion.
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 1985, to September, 2017. During this process, a maximum of 15 stocks were purchased, with no more than three an economic sector to ensure reasonable diversification. Once a quarter, stocks would be 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 15.4 per cent while the S&P/TSX composite total return index advanced 8.2 per cent. The stocks that meet our requirements for purchase are listed in the accompanying table.
As always, it is recommended that investors 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.