Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
What are we looking for?
Less risky Canadian stocks to start the new decade.
The screen
Looking back at 2019, investors should be quite happy with their North American returns, with the S&P/TSX Composite Index posting a year-to-date gain of more than 19 per cent, and the S&P 500 up around 28 per cent. As we near the end of the year, investors can reap the rewards of staying invested and settle in for a well-deserved holiday.
There is concern, however, that this happiness may be short-lived, as many believe these sky-high returns are unlikely to continue for an extended period of time.
Today’s strategy is searching for a portfolio of Canadian stocks that are poised to weather adverse markets. The aim of this strategy is to provide strong downside protection as we head into a new decade and be able to withstand any impending market volatility that may occur in the future.
This strategy ranks stocks based on two criteria: five-year beta and industry-relative earnings variability.
Five-year beta measures a company’s sensitivity relative to historical changes in the benchmark – here we use the S&P/TSX. In trending markets, a stock with beta less than one has historically moved less than the index; low values are best.
Industry-relative earnings variability measures how volatile a company’s earnings are relative to its industry median; low values are best.
Stocks that qualify must have:
- Five-year beta less than 0.6 to reduce market sensitivity. (A negative beta means the stock generally moves in the opposite direction of the market. That is, if markets fall the stock would typically rise.);
- Industry-relative earnings variability in the top two-thirds of peers (this value today is 1.8 per cent or less, including negative figures, implying the stock’s earnings variability is less than that of its industry median);
- Five-year standard deviation of monthly ROE (a measure of risk) in the top half of peers (today this value is 3.9 per cent or less);
- Market capitalization in the top half of peers (today this value is $399.9-million or higher).
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.
What we found
I used Morningstar CPMS to back test this strategy from January, 2000, to November, 2019. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their five-year beta rose to one or higher. 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 13.5 per cent while the S&P/TSX rose 6.2 per cent on the same basis. The strategy outperformed in 81 per cent of down markets (measured as quarters where the S&P/TSX experienced negative returns) compared with the benchmark.
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.
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Emily Halverson-Duncan, CFA