What are we looking for?
Momentum-driven TSX-listed stocks that also have long-term growth potential.
The screen
Momentum strategies are typically quite short term in nature with respect to selecting their underlying securities. Often these strategies will buy/sell stocks purely based on rapidly changing metrics centred around earnings report dates or fluctuations in price, causing their volatility to be significantly higher than most other types of strategies.
Growth strategies, on the other hand, often take a longer-term perspective when selecting stocks, looking for characteristics such as long-term sales growth or a consistent return on equity, which can result in these strategies having a relatively smoother return pattern.
Today, I'm showcasing a strategy that couples the best characteristics of both growth and momentum. The strategy ranks stocks based on: return on equity (measures how much a company is earning for each individual share); quarterly earnings surprise (proprietary measure of the difference between actual and expected quarterly earnings – higher value is best); and quarterly earnings momentum (measured as the growth in most recent trailing four quarters' earnings compared with the trailing four quarters' earnings lagged by one quarter – higher value is best).
In order to qualify, stocks must have:
- Return on equity greater than 5 per cent;
- Quarterly earnings surprise greater than zero;
- Quarterly earnings momentum greater than zero;
- Five-year beta (measures a company’s sensitivity relative to changes in the benchmark – here we use the S&P/TSX composite total return index) must be equal to or less than one;
- Five-year annualized cash flow growth greater than zero; · Five-year annualized sales growth greater than zero.
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 April, 1995, to December, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their quarterly earnings surprise or their quarterly earnings momentum fell below minus 8 per cent, or if their five-year beta rose to more than 1.2. 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 26.3 per cent while the S&P/TSX composite total return index returned 8.6 per cent across the same period. Downside deviation (measured as the variability of negative returns) was 7.9 per cent compared with a downside deviation of 10 per cent for S&P/TSX composite 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.