What are we looking for?
U.S. tech companies growing fast.
The screen
This week, I turn to the U.S. technology sector to look for growth ideas. The sector itself has come a long way since the dot-com bubble of the early 2000s. Since then, we've seen rapid advancements across the board with recent attention given to the rise of blockchain technology. In calendar year 2017 alone, the S&P 500 Information Technology Total Return Index advanced nearly 40 per cent. To find rapidly growing companies, I ranked technology stocks in the Morningstar CPMS U.S. database on:
- Five-year earnings per share (EPS) growth rate (on average, how much has the company increased its earnings each year in the past five years, higher figures preferred);
- Quarterly earnings momentum (the trailing four quarters of operating earnings compared with the same figure one quarter ago. Higher figures preferred);
- Market capitalization (here we prefer larger companies);
- Three-month EPS estimate revision (today’s consensus estimate for EPS compared against the same figure at month-end, three months ago);
- Nine-month price change (here we prefer companies with positive price momentum).
To qualify, companies must have at least three analysts actively covering the stock and a minimum market capitalization of US$1-billion (this limit removes the bottom one-third of tech companies in our database, which today consists of 355 stocks). Also, to ensure that companies are not propping up earnings by issuing debt, we require a debt-to-equity ratio that is in line with the sector (in the accompanying table, an industry relative D/E ratio of 0.9 would imply that the company's D/E ratio is 10 per cent lower than that of the sector).
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 December, 1993, to February, 2018. During this process, a maximum of 10 stocks were purchased and equally weighted.
Once a month, stocks were sold if their rank fell below the top 35 per cent of the ranked universe, or if EPS estimates dropped by more than 10 per cent over a three-month period. 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 18.5 per cent while the S&P 500 Information Technology Total Return Index advanced 12.5 per cent. The stocks that meet our requirements for purchase and 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.