What are we looking for?
Companies growing top line revenue with good profit margin.
The screen
This week, I look for companies trading in Canada that have shown both growth in sales and the ability to convert those sales to profits. To find them, I ranked the stocks in the Morningstar CPMS Canadian database (today this consists of 696 stocks) by the following metrics:
- Five-year sales growth (on average, how much has revenue grown each year in the past five years);
- Price-to-sales ratio (to avoid overpaying for sales growth, we prefer a lower price-to-sales);
- Net profit margin (recall this is a company’s earnings as a percentage of sales, higher figures preferred);
- Three-month estimate revision (today’s consensus estimate compared with the same figure three months ago).
To qualify, companies must have a market capitalization greater than $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 October, 2005, to September, 2018. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than three for each economic sector. Once a month, stocks were sold if their rank fell below the top 50 per cent of the ranked universe, if consensus estimates dropped by more than 10 per cent or if the stock price fell by more than 15 per cent over the trailing one, three, six or nine months. 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 19.1 per cent while the S&P/TSX Total Return Index advanced 6.5 per cent. Today, only nine stocks qualify for purchase and they are listed in the accompanying table.
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.