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My value and momentum screening uncovered these two promising stocks

Logo of Norman Rothery, photographed in the studio at the Globe and Mail in Toronto, September 07, 2012.

Deborah Baic/The Globe and Mail

Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Old trees are being removed from my neighbourhood as they near the end of their natural lives. While it's sad to see an old tree go, if you step back and look at the urban forest, it appears to be thriving.

Investors should also look up from their portfolios, from time to time, to gauge the state of the market. To do so it is useful to break down the market by sector to see which ones are faring the best and where there are bargains to be found.

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More specifically, I'll focus on price-to-earnings ratios (P/Es) and one-year total returns as my measures today. The former ratio is loved by value investors, with low-ratio stocks generally viewed as representing better bargains than high-ratio stocks. Trend followers, on the other hand, will look for momentum. In this case, it is deemed likely that stocks with high one-year returns will continue to move higher, while those with low one-year returns will probably lag. It is helpful to calculate the average and median of both measures for each sector in Canada.

Most people have a good sense of what an average is all about. One simply adds up all the values in question and divides by the number of values. The median is a little trickier, but it can be quite useful in practice. Here a list of values is sorted from high to low and the median is the value halfway through the group. That is, the median is the point at which half the values are higher and half are lower.

In almost all cases, averages and medians differ because averages tend to be influenced more by extreme results, whereas medians are not. For instance, of five trees, where four are 10 metres tall and one is 60 metres tall, the median is 10 metres, whereas the average is 20 metres.

The outlier makes a big difference to the average.

The accompanying table shows the medians and averages for both P/E and one-year total return for TSX-listed stocks by sector. (As a technical aside, only stocks with positive ratios are included in the P/E calculations. Stocks with a year's worth of trading history are included in the return figures.)

Over all, the average P/E for stocks that trade on the TSX is a hefty 29.7, but the median is a more reasonable 19.1. Here the average tends to be skewed higher because of firms with very high ratios that are suffering from what hopefully proves to be a temporary earnings slump.

Something similar happens when it comes to one-year returns. The average stock gained 20.6 per cent over the past 12 months, whereas the median gained a more modest 10.7 per cent. A few big gainers skewed the average higher.

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When it comes to sectors, financials appear to represent the best bargains at the moment, with an average P/E of 14.7 and a median P/E of 12.2.

The highest one-year average returns were scored by health care stocks at 37.1 per cent – thanks to Canopy Growth's (WEED) gain of 208 per cent plus some big percentage gains from penny stocks. But the sector also had the worst median return of minus 2.1 per cent. The best median return came from the more stable utilities sector, with an 18-per-cent gain.

Doing a little cross-pollination, a strong one-year momentum stock from within the low-P/E financial group is Clarke Inc. (CKI), with a 45.5-per-cent gain and a P/E of 5.1. On the other hand, a moderate-P/E stock from within the high-return utility group is Capital Power Corp. (CPX), with a P/E ratio of 17.6 and a one-year return of 48 per cent.

With a little luck, they'll both continue to grow skyward, much like the trees that were planted across Canada this spring.

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About the Author

Norman Rothery, Ph.D., CFA, is the founder of StingyInvestor.com and has been catering to value investors since 1995. He publishes the Rothery Report, a value stock newsletter. Norm obtained a Ph.D. in atomic physics from York University before following his passion for investing. More

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