What are we looking for?
Relatively steady, profitable companies in the Canadian energy space.
The screen
The energy sector represents almost 7 per cent of Canada’s GDP, according to Natural Resources Canada, and at the end of the first quarter of 2018 publicly traded companies in this sector represented 18.5 per cent of the S&P/TSX Composite Index. This said, for many retail investors, energy companies can be both a blessing and a curse. The stocks in this sector are highly correlated to the price of crude, which is often unpredictable, but when rallying can provide extraordinary gains in a portfolio.
This week, I use Morningstar CPMS to find companies in this space that have shown stable earnings and profits, relative to the universe of energy companies in our Canadian database (today this comprises 121 companies). To find these companies, I rank stocks in this universe on:
- Trailing five-year deviation of reported earnings (a statistical measure showing how volatile a company’s reported earnings have been, lower figures preferred);
- Average return on equity over the trailing five years (higher figures preferred);
- Five-year earnings-per-share growth rate (on average, by how much earnings grew each year in the past five years);
- Today’s median consensus estimate compared against the same figure 30, 60 and 90 days ago (higher figures preferred).
To qualify, companies must have at least three analysts actively covering the stock. Additionally, a maximum of two stocks per industry group within the energy sector were considered to ensure we were not concentrated on one type of energy company. In the accompanying table, I’ve indicated which industry group the stock belongs to (examples include exploration and production; energy services; mid-stream; integrated; and drilling).
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 May, 2002, to March, 2018. During this process, a maximum of 10 stocks were purchased and equally weighted with no more than two stocks per industry group within the energy space. Once a month, stocks were sold if their rank fell below the top 50 per cent of the ranked universe, or if consensus estimates dropped by more than 15 per cent over the aforementioned time frames. 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 10 per cent while the S&P/TSX Energy Total Return Index advanced 6.5 per cent.
The stocks that meet our requirements for purchase and 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.
Ian Tam, CFA