What are we looking for?
Less-risky Canadian stocks to start the new year.
The screen
While some investors remain extremely positive heading into 2018, others are preferring to take a more conservatively optimistic approach. With valuations being so high, building a portfolio with a focus on lower volatility is never a bad idea.
Today's Canadian strategy is the follow-up to my article last week, which looked at a conservative portfolio of U.S. stocks. The goal of these two strategies together is to form a North American portfolio built to weather unpleasant markets.
This strategy ranks stocks based on five-year beta (measures a stock's sensitivity relative to historical changes in the benchmark – in trending markets, a stock with beta less than one has historically moved less than the index – in this case, the S&P/TSX composite) and industry-relative earnings variability (measures how volatile a company's earnings are relative to its industry median). In both instances, low values are best.
Stocks that qualify must have:
- Five-year beta less than 0.6 (to reduce market sensitivity);
- Five-year standard deviation of monthly return on equity (a measure of risk) less than at least half of peers (today this value is 4.4 per cent);
- Industry-relative earnings variability less than one-third of peers (this value today is 1.8 per cent);
- Market cap at least as great as half of peers (today this value is $519.7-million).
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 January, 2000, to November, 2017. 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 15 per cent while the S&P/TSX composite total return index returned 6.2 per cent across the same period. Downside deviation (measured as the variability of negative returns) was 4.7 per cent compared with 9.8 per cent for the S&P/TSX total return index. 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.