Craig McGee is a senior consultant at Morningstar Canada.
What are we looking for?
Strong performers in the information technology sector.
IT stocks have been a big contributor to the U.S. market's continuing strength. Over the 12 months ended July 31, 2014, the S&P 500 IT sector has returned 28 per cent while the broad index has returned 17 per cent. So far this quarter, IT continues to lead the pack so I wanted to look for stocks in the sector that could continue to outperform.
The screen
Analyzing the CPMS historical U.S. database stretching back to 1993, we selected a number of attributes that have helped to drive more consistent performance from IT stocks. Specifically, I scanned the CPMS U.S. database for the 20 IT stocks from the S&P 500 with the best combination of the following metrics:
– Market capitalization (firms with lower market caps were favoured);
– Price to cash flow;
– Price to sales;
– Price to book;
– Long-term debt to equity (less debt was preferred);
– Revision of the consensus earnings per share estimate over the past two months.
More about Morningstar
Morningstar 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 did we find?
Using CPMS, I back-tested the strategy to apply the same rules-based approach starting Dec. 31, 1993. A portfolio of as many as 20 stocks was equally weighted and stocks would be replaced if their rank fell into the bottom half of all S&P 500 IT stocks.
Over the past year, this strategy generated a total return of 34.2 per cent, outpacing both the IT sector and the S&P 500. For the full period starting Dec. 31, 1993, this approach would have posted an annualized return of 18.1 per cent versus 11.2 per cent for the IT sector and 9.2 per cent for the S&P 500.
Investors are advised to do their own research before investing in any of the stocks shown here.