What are we looking for?
Canadian companies with strong sales and earnings.
The screen
One of the metrics most widely scrutinized when evaluating stocks is earnings. Companies that miss the Street’s consensus earnings target (earnings reported are less than expected) are typically looked at negatively, whereas companies that meet or exceed earnings are viewed more favourably. Historically, using earnings as a method of screening for promising stocks has proven to be very effective in regards to long-term return.
One thing to consider, however, is that earnings by themselves only tell part of a company’s story. Another useful metric is a company’s long-term sales growth. Companies can have an increase in earnings for a variety of reasons, but when coupled with growing sales, the combination can point to a company with powerful growth potential.
Today’s strategy looks to find Canadian stocks with strong earnings and sales data among the CPMS Canadian universe. This universe currently holds 702 names. The strategy ranks stocks using the following factors:
- Five-year sales growth – annualized, higher values preferred;
- Quarterly earnings surprise – a measure of the difference between a company’s actual and expected earnings, higher values preferred;
- Quarterly earnings momentum – measured as the growth in the most recent four quarters of earnings relative to the same four quarters' earnings lagged by one quarter, higher values preferred;
- Trailing return on equity – a profitability metric, higher values preferred.
In order to qualify, stocks must have positive five-year sales growth and trailing return on equity greater than at least 50 per cent of peers (that value today is 4.99 per cent or higher). In order to control market sensitivity, five-year beta relative to the S&P/TSX Composite Index must be less than one. (Beta measures a company’s sensitivity relative to changes in the benchmark – a value less than one indicates the stock is less volatile than the market.) Lastly, market capitalization must be greater than or equal to $500-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, 2002, to September, 2018. During this process, a maximum of 15 stocks were purchased. Stocks were sold if the company’s five-year sales growth declined below minus 4 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 17.7 per cent while the S&P/TSX Composite Total Return Index returned 7.9 per cent across the same period.
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, CFA, is a director, CPMS sales at Morningstar Research Inc.