What are we looking for?
Canadian value stocks well positioned for a market upturn.
The screen
With all the market volatility that has followed the COVID-19 pandemic, most investors are focused on how best to position their portfolio to withstand those fluctuations. But how well is your portfolio positioned to recoup its losses once the market itself recovers?
Historically, we’ve seen investing styles that tend to be hit harder in down markets recover more quickly. That’s not always the case, of course, but a good rule of thumb. One of the styles that gets hit the hardest in downturns is value – portfolios that hold stocks that currently trade beneath their “intrinsic value,” or what the shares are deemed to be really worth. These stocks tend to be some of the best performers after a down period.
Today, I’m showcasing a model that searches for value companies within the CPMS Canadian universe, which currently holds 694 names. The strategy ranks stocks based on:
- Price-to-trailing earnings (measured as the company’s most recent share price divided by the previous four quarters’ earnings per share, low values preferred);
- Price-to-forward earnings (most recent share price divided by the current year EPS median estimate, low values preferred);
- Price-to-book-value (most recent share price dividend by the book value per share; low values preferred);
- Cash flow to debt (a profitability ratio, higher values preferred).
In order to qualify for the value model, the stocks must have:
- A trailing and forward P/E in the bottom half of all Canadian stocks – that value today is 13.2 times and 12.8 times, respectively, or below;
- A market capitalization in the top half of all Canadian stocks – that value today is $269.2-million or higher;
- A payout ratio (calculated as dividends per share divided by EPS) less than 80 per cent to ensure earnings were not all being paid out as dividends.
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.
What we found
I used Morningstar CPMS to back-test this strategy from December, 1991, to March, 2020. During this process, a maximum of 15 stocks were purchased. Stocks were sold if the company’s payout ratio rose above 100 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 10.8 per cent while the S&P/TSX Composite Index returned 7.4 per cent on the same basis. It’s also worth noting that after the 2008 credit crisis, this model enjoyed a total return of 57.7 per cent in 2009 compared with the benchmark, which advanced 35.1 per cent.
Note that only 14 stocks qualify for purchase into the strategy today and are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed below.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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Emily Halverson-Duncan, CFA