What are we looking for?
Upward-driving Canadian stocks that also screen well on a technical basis.
The screen
There is an age-old debate over what style of company analysis is most effective – fundamental or technical. Fundamental analysis is a method used to evaluate how much a company is worth by focusing on firm-specific factors (such as earnings, revenue, etc.) and how they relate to macroeconomic conditions. On the other hand, technical analysis focuses on forecasting the direction of stock prices by looking for trends in historical market data such as price and trading volume.
Today, I'm showcasing a strategy that is built based on fundamental momentum variables but is coupled with a technical variable to help determine appropriate timing as to when to buy and sell securities. The strategy's aim is to identify the upward movement of a momentum strategy while timing appropriate entrances and exits from portfolio positions, without taking on excessive risk or trading too frequently.
The strategy ranks stocks based on quarterly earnings momentum (measured as the growth in the most recent trailing four quarters earnings relative to the trailing four quarters' earnings lagged by one quarter – higher value is best), quarterly earnings surprise (a proprietary measure of the difference between actual and expected quarterly earnings – higher value is best) and five-year beta (beta measures a stock's historical sensitivity to a 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 – lower value is best).
Stocks that qualify must have:
- A quarterly earnings momentum greater than or equal to zero;
- A quarterly earnings surprise greater than or equal to zero;
- A five-year beta less than 0.7 (to reduce relative market sensitivity);
- A debt-to-equity ratio less than or equal to 1.1 (to ensure highly leveraged companies are excluded);
- A price change relative to 200-day moving average greater than 3 per cent (a technical indicator).
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 November, 2002, to November, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their price relative to the 200-day moving average dropped below minus 10 per cent. 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 27 per cent while the S&P/TSX composite total return index returned 7.7 per cent across the same period. Downside deviation (measured as the variability of negative returns) was 7.2 per cent, compared with a downside deviation of 8.7 per cent for the S&P/TSX composite total return index. Lastly, annualized turnover was 47 per cent. This is equivalent to 47 per cent of the portfolio holdings being traded each year based on historical trades. This we take as a relatively good signal because less turnover means fewer trades for investors, translating into lower trading costs.
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.
Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.