What are we looking for?
A mixed portfolio of Canadian value and growth stocks.
The screen
It’s not uncommon for equity investors to categorize themselves based on their preferred investment style, for example, value investors or income investors.
While this practice has its benefits, there’s also always the option to manage multiple investment styles rather than just one. Doing so will offer the advantage of having a better diversified portfolio that may be able to weather adverse markets better as each individual style goes in and out of favour.
Today, my strategy is built using two different styles: value and growth. The value portion will represent 50 per cent of the strategy, and the growth portion will represent the other 50 per cent. Stocks will be selected from the CPMS Canadian 250, which are the largest 250 stocks in the CPMS Canadian universe by market float (the number of shares actually available to trade).
The value portion ranks stocks based on:
- Price to trailing earnings ratio – low values preferred;
- Three-month earnings per share (EPS) estimate revision (percentage) – measures the percentage change in EPS estimates across the last three months with high values preferred;
- Price to trailing cash flow ratio– low values preferred;
- Price to book value ratio – low values preferred;
The growth portion ranks stocks based on:
- Trailing return on equity (percentage) – high values preferred;
- Five-year annualized cash flow growth (percentage) – high values preferred;
- Five-year annualized sales growth (percentage) – high values preferred.
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 April, 1995, to April, 2019. During this process, a maximum of 10 stocks per investment style were purchased, for a strategy maximum of 20 stocks. Stocks were sold in the value portion if their three-month EPS estimate revision dropped below -10 per cent and were sold in the growth portion if their quarterly earnings momentum or quarterly earnings surprise dropped below -6 per cent. When sold, the positions were replaced with the highest-ranked stock not already owned in that particular portion of the portfolio.
Over this period, the strategy produced an annualized total return of 13.8 per cent while the S&P/TSX Composite Total Return Index returned 8.4 per cent across the same period. The growth portion returned 15.4 per cent across this time period while the value portion returned 10.4 per cent. While the growth portion did better in terms of returns compared to the pooled model, it’s worth noting that the pooled model had a downside deviation (variability of negative returns) of 9.6 per cent versus the growth portion’s downside deviation of 10.8 per cent. Stocks that qualify for purchase into the both parts of 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 below.
Emily Halverson-Duncan, CFA, is a Director, CPMS Sales at Morningstar Research Inc.
Emily Halverson-Duncan, CFA