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What are we looking for?

Companies in sectors benefiting from an interest rate hike.

The screen

On Wednesday, the Bank of Canada hinted at a potential hike in interest rates within the next 12 months. Historically, three sectors in particular benefit from rising interest rates: financials (who benefit with increased lending rates across business lines), consumer discretionary (benefiting from increased consumer spending on positive economic growth) and industrials (benefiting from increased production through higher demand for goods). This week, I focus on these three sectors in particular and rank stocks on the following factors:

  • Five-year normalized earnings per share, cash flow and sales growth (here we use a statistical method called linear regression to calculate the average annual growth rate of these three factors over the past 60 months);
  • Annual earnings momentum (a short-term growth metric comparing the last four quarters of earnings per share against the same figure four quarters ago);
  • Earnings variability (a proprietary CPMS metric measuring how volatile a company’s historical earnings are – lower figures preferred).

To qualify, stocks must have a market cap of at least $90-million (this figure is meant to exclude the bottom one-third of the CPMS universe by size, which today consists of 720 companies).

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 January, 1995, to March, 2017. During this process, a maximum of 15 stocks were purchased with a maximum of five stocks a sector, defined above. Stocks are sold if their rank fell below the top 25 per cent of the universe or if consensus estimate for EPS dropped by more then 10 per cent over the trailing three months (indicated in the table under the column heading "3M EPS estimate revision"). When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio, keeping in mind the aforementioned sector limits.

Over this period, the strategy produced an annualized total return of 13.4 per cent while the S&P/TSX total return index produced 8.5 per cent. Stocks that qualify for purchase into the strategy today are listed in the accompanying table.

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.

Top stocks in select sectors

RankCompanyTickerMkt Cap ($Mil)Sector5Yr EPS Growth (%)5Yr Sales Growth (%)5Yr CF Growth (%)Annual Earns. Momentum (%)3M EPS Estim. Revision (%)Earns. VariabilityDiv. Yield (%)
1Waste Connections Inc.WCN-T 20,853.8 Industrials20.619.719.232.93.04.70.8
2Cdn National RailwayCNR-T 75,014.4 Industrials15.39.714.03.11.82.41.7
3Amaya Inc.AYA-T 3,285.1 Cons. Discr.40.570.540.051.111.317.40.0
4Richelieu Hardware Ltd.RCH-T 1,702.9 Industrials11.812.810.49.20.02.40.8
5People Corp.PEO-T 231.4 Industrials61.218.460.311.50.015.00.0
6Bank of Nova ScotiaBNS-T 93,705.9 Financials6.95.85.79.00.91.73.9
7Industrial AllianceIAG-T 6,050.7 Financials25.83.76.216.51.64.32.5
8TMX Group Ltd.X-T 3,954.0 Financials6.77.88.623.32.83.62.5
9Royal Bank of CanadaRY-T 142,851.0 Financials9.06.27.07.03.12.93.6
10Toronto-Dominion BankTD-T 123,049.7 Financials7.410.212.17.61.83.83.6
11Dollarama Inc.DOL-T 13,296.5 Cons. Discr.31.219.917.223.04.411.80.4

Source: Morningstar Canada

Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.