What are we looking for?
Momentum stocks that exhibit a low degree of environmental risk relative to global peers.
The screen
This week, the Canadian Securities Administrators, the umbrella organization of provincial and territorial securities regulators, announced a proposal to require Canadian stock issuers to begin providing climate-change related disclosures. At present, Canadian companies are not required by regulation to disclose sustainability-related items with a great degree of detail, thus limiting the voluntary disclosure of this information to larger issuers with enough resources to do so.
The proposed disclosure requirement will include the reporting of greenhouse gas emissions, and the risks related to them in a comply-or-explain framework (which means companies must either disclose this information or explain why they haven’t). The proposed requirement is currently out for public comment.
These required disclosures should enable investors to make better informed investment decisions around climate-related risk. With this in mind, today I use Morningstar CPMS to search for companies that have been deemed to exhibit a low degree of environmental risk, while also showing growth characteristics. To do this, I ranked the 718 stocks in our Canadian database on the following factors:
- The Morningstar Sustainalytics’ environmental risk score. The score measures the degree to which a company’s economic value may be at risk driven by environmental issues. This is based on the company’s exposure to industry-specific material risks and how well a company is managing those risks. The score ranges from zero to 100, with a score of zero implying that risks have been fully managed, while a score of 100 implies there is a significant degree of unmanaged environmental risk. Readers should note that the score compares a company against others in the same subindustry from across the world.
- Five-year deviation of return on equity (a measure of volatility – lower figures preferred, implying that ROE has been consistent over the past five years);
- Five-year average ROE;
- Five-year cash flow growth rate (the percentage that operating cash flow has grown each year on average over the past five years);
- Three-month price momentum (the average price over the past six months compared with the average price over the six-month period ended three months ago).
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
I used Morningstar CPMS to back-test the strategy from April, 1995, to September, 2021, assuming a 15-stock portfolio that holds no more than three stocks per economic sector, and noting that the environmental risk metrics were not applied until November, 2018. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics, or if the environmental risk score exceeded 10. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, keeping in mind the aforementioned sector limits.
On this basis, the strategy produced an annualized total return of 14.4 per cent, while the S&P/TSX Composite Total Return Index gained 8.7 per cent. The stocks that meet 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.
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