What are we looking for?
U.S.-listed large caps that show value relative to their sectors.
The screen
With the first half of 2019 now behind us, U.S. equities are faring exceptionally well despite the backdrop of uncertainty about global trade. The S&P 500 has shown a year-to-date total return of 21.2 per cent, erasing the 4.4-per-cent loss last year. This week, I use Morningstar CPMS to look for the largest U.S. companies that are trading at a discount relative to their sector peers. To do this, I first rank companies in our U.S. database (today consisting of 2,155 stocks) on the following metrics:
- Price-to-sales and price-to-forward-earnings ratios relative to their sector medians (in the table, a reading of 0.4, for example, would imply that the company’s price-to-sales or forward P/E figure is 60 per cent lower than that of the sector to which it belongs);
- Latest return on equity and five-year average return on equity (ROE) are profitability metrics, higher figures preferred).
To qualify, stocks must have a market capitalization greater than US$18.4-billion (this figure meant to only include the top one-sixth of stocks in the universe by size).
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 120 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 December, 1998, to June, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than three an economic sector. Once a month, stocks were sold if their rank fell below the top 35 per cent of the universe, or if the company missed earnings expectations by more than 5 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 10.4 per cent while the S&P 500 Total Return index advanced 6.4 per cent on an annualized basis.
The stocks that qualify for purchase today are listed in the table below. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.
Ian Tam, CFA