What are we looking for?
Value-focused stocks within the Canadian universe.
The screen
Value investing is a common type of investing whereby investors search for stocks that are currently undervalued compared with other stocks in their peer group. This type of strategy is typically best suited for long-term investors who are comfortable with a buy-and-hold philosophy and would rather avoid excessive trading more commonly associated with growth and momentum strategies.
In today's market, a lot of stocks are considered overvalued due to their valuations being driven up to extreme highs over the years. While this may imply that value stocks are not easily found, I believe it is still possible to find value with the proper screens.
Today's strategy looks to find Canadian value stocks among the CPMS Canadian universe. This universe currently holds 711 names. The strategy ranks stocks using the following factors:
- Price-to-trailing-earnings (measured as the company’s most recent share price divided by the previous four quarters’ earnings per share – low values best);
- Price-to-book-value (measured as the company’s most recent share price divided by the book value per share; low values best);
- Price-to-trailing-cash-flow (measured as the company’s most recent share price divided by the most recent four quarters of operating cash flow – low values best);
- Five-year beta relative to the S&P/TSX Composite Index (measure of a company’s sensitivity relative to changes in the benchmark – a value less than one would indicate the stock is less volatile than the broader market – low values best).
In order to qualify, stocks must have a trailing P/E in the bottom half of all Canadian stocks (that value today is 18.89 or below); a P/B in the bottom half off all Canadian stocks (that value today is 1.5 or below); and a P/CF in the bottom half of all Canadian stocks (that value today is 8.55 or below). Payout ratio (calculated as dividends per share divided by earnings per share) was required to be less than 60 per cent to ensure earnings were not all being paid out as dividends.
Lastly, in order to control volatility, five-year beta relative to the S&P/TSX must be equal to or 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 January, 2000, to February, 2018. During this process, a maximum of 15 stocks were purchased. Stocks were sold if the company's payout ratio rose above 80 per cent. 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 16 per cent while the S&P/TSX Composite Total Return Index returned 6 per cent across the same period.
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 a director, CPMS sales at Morningstar Research Inc.