What are we looking for?
Stocks that analysts expect to grow while keeping in mind valuations.
Despite continuing North American free-trade agreement negotiations and unclear rules on whether the current U.S. President has the authority to exclude Canada from the agreement, Street analysts seem to be fairly bullish in the short term. Case in point, 201 of 245 companies in the S&P/TSX Composite Total Return Index currently show positive year-over-year earnings growth projected for the coming year based on Street consensus. For those who share this optimistic outlook, the following screen may provide some ideas. The strategy ranks stocks simply on two factors:
- Forward PEG ratio (a comparison of the forward price-to-earnings ratio against the projected growth rate of earnings for the upcoming fiscal year).
- Five-year deviation of earnings (a volatility measure that shows how consistent earnings have been over the past five years, lower figures preferred).
To qualify, companies must have at least three active analysts covering the stock and those analysts (on a median consensus basis) must have a positive projected year-over-year earnings growth rate.
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 March, 1992, to August, 2018. During this process, a maximum of 20 stocks were purchased and equally weighted with no more than four for each economic sector. Once a month, stocks were sold if their rank fell below the top 25 per cent of the ranked universe or if analysts projected that the company would fail to increase earnings in the coming fiscal year. 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 12.4 per cent while the S&P/TSX Total Return Index produced 8.8 per cent. The stocks that qualify for purchase today are listed in the table below.
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.