What are we looking for?
Companies sharing the same fundamental characteristics as top performers over the trailing three months.
The screen
Although the S&P/TSX composite index has remained fairly flat year to date, there are certainly some high fliers in the mix. This week, I used Morningstar CPMS to home in on companies that share the same fundamental characteristics as the top price performers over the trailing three-month period by first looking for the best three performers within each sector over the past three months (a total of 33 companies in 11 sectors). The idea here is to provide ideas to investors who believe these fundamental characteristics will continue to be rewarded in the medium to long term. On aggregate, these 33 companies had the following characteristics:
- Low price-to-book and price-to-sales ratios;
- High quarterly earnings momentum (latest four quarters reported earnings per share compared against the same figure one quarter ago);
- High quarterly cash flow momentum (latest four quarters cash flow compared against the same figure one quarter ago);
- Positive earnings surprise in the latest quarter;
- Next year’s growth rate estimate for EPS (next fiscal year’s median EPS estimate compared against the current fiscal year’s median estimate for EPS).
Using these same factors, I then used Morningstar CPMS to rank all the stocks in its database (currently, the database consists of roughly 700 Canadian companies) on the best combination of these characteristics. In this analysis, companies with less than three active EPS estimates were excluded.
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 December, 1991, to July, 2017. During this process, a maximum of 25 stocks were purchased with a maximum of five per economic sector to ensure reasonable diversification. Stocks are sold if their rank fell below the top 35 per cent of the universe. 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 16.8 per cent while the S&P/TSX composite total return index gained 8.4 per cent. The top 20 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.