What are we looking for?
Profitable picks amongst Canadian-listed metals and mining stocks.
The screen
As worries of inflation continue alongside talk of a looming recession, investors might be on the lookout for companies that help combat these portfolio-degrading forces.
Though not a relatively stable asset like physical gold (which tends to remain steady during market panics and is often cited as an inflation hedge), metals and mining companies do expose investors to underlying commodity prices, granting the opportunity for returns greater than the physical commodity, alongside greater risks.
In the Morningstar CPMS Canadian database, there are a whopping 157 metals and mining companies. That said, experienced investors know that companies in this industry are often rife with volatility. To this end, today I use Morningstar CPMS to look for companies in this industry that exhibit relative stability and fundamental profitability over the medium term by first ranking the stocks in this industry on the following factors:
- Latest reported net profit margin (calculated by dividing the earnings a share by revenue a share);
- Five-year average return on equity (calculated by dividing net income by shareholder equity);
- Five-year deviation of ROE (measuring the consistency of return on equity, lower figures preferred);
- Five-year EPS growth rate (on average, how much earnings per share have grown each year over the past five);
- Five-year historical price beta (a safety factor, measuring a stock’s sensitivity to the benchmark index. Stocks with a beta of less than one have historically moved less than the index in trending markets, which is preferred here).
To qualify, stocks must have a market cap greater than $500-million, a figure meant to exclude the bottom half of stocks in the database by size. Given the rapid rise of interest rates and the increased cost of servicing outstanding debt, I also placed a screen on sector-relative debt-to-equity and sector-relative cash-flow-to-debt ratios to include only companies that are less leveraged than the broader sector (lower debt-to-equity, and higher cash-flow-to-debt).
What we found
Readers will quickly notice the generally lacklustre one-year performance of many qualifiers and are reminded that profitability here is measured fundamentally (via ROE and net profit margin). It does appear, however, that the market has not favoured these companies over the past 12 months.
Regardless, to understand whether the strategy worked over a longer period, I used Morningstar CPMS to back-test the strategy from December, 1990, to May, 2022, assuming an equally weighted 10-stock portfolio consisting of only metals and mining companies. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics. When sold, stocks were replaced with next qualifying stock not already held in the portfolio. On this basis, the strategy produced an annualized total return of 12 per cent, while the S&P/TSX Materials Total Return Index produced 5.8 per cent. The stocks that meet the requirements to be purchased into the strategy today are listed in the accompanying table.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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.