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What are we looking for?

Momentum-driven stocks that capitalize on the upside while protecting on the downside.

The screen

Traditional momentum strategies are typically associated with extremes – extreme highs and lows, extreme turnover and extreme risk. These strategies are usually best suited for active, aggressive investors with a high risk tolerance. While the long-term returns can be quite attractive, the accompanying volatility tends to be too much for the average investor to stomach.

Today I'm showcasing a strategy that incorporates some of the core elements of a momentum strategy while placing a cap on each stock's market sensitivity in hopes of reducing risk on the downside. This strategy ranks stocks using the following factors:

• Quarterly earnings momentum (measured as the growth in the most recent trailing four quarters of earnings relative to the trailing four quarters' earnings lagged by one month);

• Five-year annualized cash flow growth (a profitability metric);

• Trailing return on equity relative to the industry median (high value is best);

• Quarterly earnings surprise (a proprietary measure of the difference between actual and expected quarterly earnings);

In order to qualify, stocks must have non-negative values for all four of the ranking criteria listed above. Stocks must also have both their most recent one-day price change and one-month price change with values greater than or equal to zero. Five-year cash flow growth is required to be in the top third of peers.

Lastly, beta over five years (measures a company's sensitivity relative to changes in the benchmark – here we use the S&P/TSX composite index) must be less than 1.10.

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 October, 2002, to May, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their rank fell below the top 40 per cent of the universe or if the company's one-day or one-month price dropped more than 15 per cent. 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 23.9 per cent while the S&P/TSX composite total return index advanced 9.2 per cent. Downside deviation (a measure of the variability of negative returns) was 6.8 per cent compared to the S&P/TSX, which had a downside deviation of 8.6 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.

Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.

Momentum stocks for the less aggressive investor

RankCompanyTickerMarket Cap ($Mil) Quarterly Earnings Momentum (%)5Yr Cash Flow Growth (%)ROE Rel. to Industry MedianQuarterly Earnings Surprise (%)1 Day Price Change (%)1 Month Price Change (%)5 Yr BetaDividend Yield (%)
1Patient Home MonitoringPHM-X179.415.540.526.70.8015.90.20
2Constellation SoftwareCSU-T15,092.802.760.692.400.41.90.30.75
3First National FinancialFN-T1,624.503.416.232.51.30.77.20.96.83
4CCL Industries Inc.CCL.B-T11,671.202.630.410.32.70.33.50.60.7
5Premium Brands HoldingPBH-T2,829.006.722.39.132.32.60.41.77
6Equitable Group Inc.EQB-T1,042.209.711.365.61.326.70.91.45
7Firm Capital MortgageFC-T320.87.64.4011.212.407.05
8Gildan ActivewearGIL-T9,374.00622.73.53.20.56.50.51.2
9CI Financial Corp.CIX-T7,272.902.9825.200.820.75.15
10Intertape Polymer GroupITP-T1,465.703.717.712.30160.53.02
11Cdn National RailwayCNR-T80,712.903.314.215.600.91.80.71.55
12Thomson Reuters Corp.TRI-T44,463.106.19.94.64.10.64.80.42.98
13Rogers Sugar Inc.RSI-T611.94.619.53.70.60.83.80.75.53

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