What are we looking for?
Fundamentally weaker stocks in the United States trading near their 12-month highs, for the contrarian investor.
Today's model also serves as a warning sign to investors who may own stocks that show the following characteristics.
The screen
Although the S&P 500 showed a positive four-quarter result, I think most investors agree that 2015 was a fairly volatile year relative to previous years, following what was essentially a five-year bull market.
With this in mind, I revisit the Morningstar CPMS U.S. Dangerous strategy, which looks ranks stocks based on:
- Low cash-flow-to-debt ratios;
- High debt-to-equity ratios;
- Low quarterly earnings momentum (latest four quarters of reported earnings per share versus the same figure one quarter ago);
- High forward price-to-earnings ratios relative to the median of the sector.
The above factors are contrarian in nature, with the intent of looking for companies with high leverage and low cash flows, and which appear overvalued. To qualify, stocks must have a market cap of more than $500-million (U.S.) or more, and a three-month daily average trading volume more than $2-million.
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
Morningstar CPMS has tracked the performance of the U.S. Dangerous model since December, 1993. The strategy holds a maximum of 40 stocks, equally weighted. Stocks are sold if they fell outside the top 30 per cent of the ranked universe. Over this period, the strategy produced an annualized total return of minus 0.7 per cent while the S&P 500 total return index gained an annualized 8.8 per cent.
In the trailing 12-month period ended Jan. 31, the strategy resulted in a loss of 28.9 per cent while the S&P 500 declined 0.7 per cent.
In the accompanying table, qualifying stocks are sorted by their price relative to the most recent 12-month high.
As always, investors are encouraged to conduct their own independent research before acting on any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.