What are we looking for?
Stable stocks with the ability to generate upward momentum.
The screen
When you hear the term conservative investment, your first thought may be low risk implies low return. While this assumption has some merit to it – as less volatile strategies tend to produce lower, more stable returns – a conservative strategy does not necessarily require giving up all of the upside.
My strategy this week looks for conservative stocks that offer an attractive upside. The strategy ranks stocks using earnings variability (a measure of the volatility of a company's earnings per share, low values are best) and the stock's price change from its 12-month high (a momentum factor, least-negative value is best).
In order to qualify, stocks must have:
- Quarterly earnings momentum (measured as the growth in most recent trailing four quarters earnings relative to the trailing four quarters earnings lagged by one quarter – percentage change must not be negative);
- Quarterly earnings surprise (proprietary measure of the difference between actual and expected quarterly earnings – percentage change must not be negative);
- Earnings variability lower than at least 50 per cent of peers (today, this value is measured as less than 16.9);
- Debt-to-equity ratio less than one.
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, 1985, to October, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their rank fell below the top 50 per cent of the universe; if the company's quarterly earnings momentum or quarterly earnings surprise fell below minus 8 per cent; or if the company's debt to equity ratio grew above 1.2. 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 15.7 per cent while the S&P/TSX composite total return index returned 8.3 per cent across the same period. Standard deviation (measured as the variability of total returns) was 10.7 per cent compared with the S&P/TSX composite total return index, which had a standard deviation of 14.3 per cent. 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 here.
Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.