What are we looking for?
Large-cap stocks with leadership potential.
One of the biggest investing stories of the year so far has been the outperformance of large-cap stocks. This is a reversal of last year's pecking order, in which the smallest stocks posted the biggest gains. As good as 2013 was for the large-cap S&P 500 index, which rose by 30 per cent, it was even better for the small-cap Russell 2000 index, which gained 37 per cent. The year was better still for the Russell Microcap index, which added 44 per cent.
This year, the markets have rewarded size. The S&P 500 is up by 7 per cent so far this year, compared to moderate pullbacks for the smaller-cap benchmarks. Meanwhile, Canadian large caps have topped them all, with the TSX 60 index up by 12 per cent year-to-date.
With the biggest stocks clearly driving market gains, we looked for large-cap stocks that might still have room to move.
How did we do it?
We first filtered the Canadian and U.S. markets by market cap, with a minimum of $3-billion (Canadian) for Canadian-listed stocks and $50-billion (U.S.) for U.S. equities.
Beyond sheer size, we looked for indications of value.
We capped the forward price-to-earnings ratio, which divides the current share price by estimated earnings over the next year, at 18.
We also wanted companies with manageable debt levels, so the maximum debt-to-equity ratio was set at 60 per cent.
Stocks with the safety of a dividend were given preference, with a minimum dividend yield of 2 per cent.
Lastly, we screened for return on equity based on estimated earnings, one measure of potential future profitability. Eligible stocks needed to have an ROE of at least 15 per cent.
What did we find?
For the Canadian market, energy and financial names dominate the results, which is unsurprising, given the share of the TSX those sectors claim, and the solid returns they have generated this year. The lone outlier is Jean Coutu Group Inc., the Quebec pharmacy chain, which will have to uncover more acquisition opportunities if it is to maintain a high rate of growth.
The U.S. results also concentrate on two top-performing sectors year-to-date: information technology and health care. To identify which of these stocks, if any, might benefit from a large-cap stock surge, investors should do their own research.