What are we looking for?
Short-term earnings growth combined with long-term earnings consistency.
The screen
By combining short-term growth with consistency, my aim is to uncover stocks that might have improved chances of weathering a downturn despite the short-term increase in stock price. I used Morningstar CPMS to create a strategy that ranks stocks based on:
- Quarterly earnings momentum (past four quarters of earnings compared against the same figure four quarters ago, higher figures preferred);
- Next-quarter earnings momentum (past three quarters of earnings plus the current median estimate for the upcoming quarter earnings, compared against the same figure four quarters ago, higher figures preferred);
- Nine-month price change (here we prefer companies trending upward over the last nine months);
- Earnings variability (a proprietary metric measuring how consistent a company’s reported earnings have been over the long term, lower figures preferred).
To qualify, the company must have at least three analysts that actively cover the stock, and the debt-to-equity ratio of the company must be lower than or equal to the median of the sector to which it belongs, avoiding overly leveraged companies. (In the table, a company showing a figure of 0.49 indicates that the stock has a debt-to-equity ratio that is 51-per-cent lower than the median of the sector.)
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 April, 1998, to May, 2017. During this process, a maximum of 10 stocks were purchased with a maximum of three per economic sector to ensure reasonable diversification. Stocks are sold if their rank falls below the top 35 per cent of the universe, or if the company's earnings turn negative. 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 11.2 per cent while the S&P/TSX composite total return index gained 6.2 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.