What are we looking for?
Canadian stocks with year-to-date price declines that have shown growth characteristics.
The screen
It’s been a choppy few weeks for Canadian equity markets. Though the S&P/TSX Composite is higher than it was since the start of the year, the path to get here was far from smooth. Today, we seek Canadian-listed companies that, for whatever reason, appear beaten down in terms of price action, but continue to exhibit positive, long-term earnings and cash flow growth. To find these companies, I used Morningstar CPMS to screen the 704 companies in our Canadian database that have shown a year-to-date price change worse than minus 7.7 per cent (a figure meant to find stocks that have underperformed the top two-thirds of Canadian-listed companies on a year-to-date basis). I then ranked these companies on the following factors:
- Five-year average return on equity (a profitability metric, higher figures preferred);
- Five-year earnings per share and cash flow growth rates (both growth metrics, measuring how much bottom line earnings and operating cash flows have grown annually, on average, over the past five years);
- Three-month EPS estimate revision (a sentiment indicator comparing the current Street estimate on earnings with what it was at month-end three months ago, higher figures preferred).
Only stocks with a market capitalization greater than $170-million were considered, a figure meant to exclude the bottom one-third of stocks by size in our database.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter.
What we found
I used Morningstar CPMS to back-test the strategy from April, 1995, to February, 2022, assuming an equally weighted 15-stock portfolio with no more than four stocks per economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the index based on the above metrics, or if estimate revisions fell by more than 15 per cent. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, considering the aforementioned sector limits. On this basis, the strategy produced an annualized total return of 13.1 per cent, while the S&P/TSX Composite Total Return Index advanced 8.8 per cent.
Only 14 stocks meet requirements to be purchased into the strategy today and they are listed in the table.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA