What are we looking for?
Canadian companies retiring debt but still growing earnings.
The screen
As investors patiently await the Bank of Canada’s interest rate decision on July 11, market participants have recently become less sure that Governor Stephen Poloz will be increasing interest rates. One thing is likely, though – rates probably won’t go down in the near term. In a rising interest rate environment, companies with high levels of debt on their balance sheets may be negatively affected (based on the fact that their interest costs will increase). This week, I use Morningstar CPMS to look for companies that have reduced their total debt, but are still growing earnings. To do this, I first rank stocks by:
- Percentage reduction in total debt over four quarters (calculated as the reported total debt four quarters ago, compared with the same figure as of last report, higher figures preferred);
- Five-year earnings-per-share growth rate (on average, how much a company’s operating earnings have grown each year over the past five years);
- Three-month EPS estimate revision (today’s median consensus estimate on EPS compared with the same figure three months ago);
To qualify, companies must have a market cap greater than $115-million (this figure is meant to exclude the bottom one-third of companies in the CPMS universe by market cap; today our database consists of 701 Canadian companies). In addition, only companies with a positive return on equity were considered to ensure profitability for shareholders.
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 November, 2001, to May, 2018. During this process, a maximum of 20 stocks were purchased and equally weighted with no more than five for each economic sector. Once a month, stocks were sold if their rank fell below the top 35 per cent of the ranked universe. 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 13.2 per cent while the S&P/TSX Composite Total Return Index advanced 7.6 per cent.
The stocks that meet our requirements for purchase are listed in the accompanying table. 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.