What are we looking for?
Canadian momentum stocks that protect on the downside.
The screen
Momentum investing has always been attractive to investors, especially given the high returns typically associated with that style. It also usually means higher volatility – and risk – which is why some investors shy away from momentum strategies. But is this excess volatility always present?
Today I’m showcasing a strategy that looks for Canadian momentum stocks within the CPMS Canadian universe that doesn’t involve taking on excessive risk.
This strategy ranks stocks based on:
- Quarterly earnings momentum (measured as the growth in the most recent four quarters of earnings relative to the same period of earnings lagged by one quarter – higher values are better);
- Quarterly earnings surprise (a measure of the difference between actual and expected quarterly earnings – we’re looking for higher values);
- Price change from 12-month high (a momentum factor, least-negative values are preferred).
Stocks that qualify must have:
- Quarterly earnings momentum greater than zero;
- Quarterly earnings surprise greater than zero;
- Price relative to the 200-day moving average (a technical indicator) greater than 3 per cent;
- Five-year beta (measures the sensitivity of a stock relative to a benchmark – here we use the S&P/TSX Composite) that is less than or equal to one. Recall that a stock with a beta of less than one moves to a smaller degree than the benchmark.
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 February, 1999, to June, 2020. During this process, a maximum of 20 stocks were purchased. Stocks were sold if their price relative to 200-day moving average fell below minus 15 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 26.2 per cent while the S&P/TSX Composite Total Return Index returned 7 per cent on the same basis.
Downside deviation (variability of negative returns, lower values better) was 9.3 per cent compared with the S&P/TSX Total Return Index, which had a downside deviation of 10 per cent. It is also worthwhile to note that during periods the market declined (defined as quarters the index experienced negative returns), the strategy outperformed 79 per cent of the time.
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 below.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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