What are we looking for?
Canadian small- and mid-cap stocks with strong earnings and price momentum as we start 2014.
How we did it
Our friend Craig McGee, senior consultant at Morningstar Canada, says he filtered the CPMS Canadian database for the 20 highest-ranking stocks with the best combination of the following metrics:
- Return on equity in the last four quarters;
- Quarterly earnings momentum, or the rate of change in earnings per share over the most recent four quarters, compared with the equivalent measure from a quarter earlier;
- Positive earnings surprises for the latest quarter;
- Consensus earnings estimate revisions over the past three months;
- Price momentum over the past year.
To ensure he picked small- and mid-cap stocks, Mr. McGee excluded the top 25 per cent of stocks by market capitalization. The lowest 25 per cent of the database based on average monthly volume was also excluded to remove the most illiquid names.
"I then used CPMS to backtest the strategy beginning Dec. 31, 1986. The best ranking stocks at that point in time were selected and equally weighted, and each month, stocks would be sold if they fell outside of the top 20 per cent of the database," he said.
More about Morningstar
Morningstar 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
Over the 27-year period, the strategy produced an annualized total return of 30.8 per cent while the BMO Canadian Small Cap Index posted a return of 7.5 per cent, Mr. McGee said. In 2013, the strategy posted a return of 66.3 per cent versus 8.3 per cent for the benchmark. The strategy outperformed the index in 25 of the 27 years tested.
As always, do your own research before buying any of the stocks listed here.