In Part 1, we took a simple factor (10-year total return) and identified the top 100 companies. In Part 2, we looked at a broader range of factors, such as 3, 5 and 10-year EPS growth, return on equity and profit margin.
In Part 3, we demonstrated how to select the top 100 companies in each of these categories and added dividend growth as a new factor. To build a list of qualifiers for Canada's Top 100 Companies, we simply took the top 100 from each factor and added them to a master list. Our qualifier's list contains 246 companies and is a great place to start.
Next, we need to find a way to sort this list on a combination of factors. We do this by building a Scoring Model. For demonstration purposes, we took the factors used to identify our qualifiers. The graphic below shows the scoring model that we developed. It is relatively simple and follows the principle of being approximately correct instead of precisely wrong. Different factors work better during specific periods of an economic cycle. In this case, we equal weighted the factors so we don't put all our eggs in one basket.
Based on our scoring model, the top 10 stocks on the list are:
In our next session, we are going to use a proprietary YCharts fundamental score to eliminate companies from the list that score poorly to identify Canada's Top 100 Companies.
To view this week's Huddle, please see the video below. Please note: We are changing the name of The Huddle to "Inside The Numbers" next week. If you would like to participate in live "Inside The Numbers" sessions or have us set up a free 7-day trial to YCharts, e-mail firstname.lastname@example.org. There is no cost or obligation.
In last week’ session, we took the first step in identifying Canada’s Top 100 Companies. We took a single factor (return to shareholders over the past five to ten years).
Normally, we simply screen for a number of factors. For example, we might screen for US companies, with a market cap of $5 Billion that have achieved better than average performance in specific factors. For example, we might use the following screen:
In this session, we used the YCharts Equity Screener to look at similar factors to identify approximately 100 top-ranked Canadian companies for each factor. This approach may help us to include Canadian growth companies, like Boyd Group or Constellation Software that may not make a broader screen.
To begin, we started with total return to shareholders. Total return to shareholders should only be used for longer periods of time, such as five to ten years as stock performance may lead you in a very bad direction if you look at 3-month to 1-year stock performance. Over longer periods, you may be able to say that “You can fool the market some of the time but not for ten years.” You should be able to find most of the names generated by this screen on other fundamental factors.
The top 10 companies from a 10-year total return screen are:
Next, let's screen for long-term (10-year) EPS Growth. Notice the stocks on both lists?
Then, five year EPS Growth:
And three-year EPS Growth
Making the top ten percent in any category should lead us to give those companies some consideration.
Next, let's look at Return On Equity. Who made the top 10?
And finally, Profit Margin:
For the Huddle, we chose roughly 100 companies from each category for a total of 228 companies. In the next session, we will drill down further.
For a visual description of the process above, please watch the recording of the October 31st Huddle below.
Building a strong investment portfolio is similar to a general manager of a National Hockey League team building a Stanley Cup champion.
In the 2006 draft, the Chicago Black Hawks chose Jonathan Toews third overall and followed that by choosing Patrick Kane the following year with the first overall pick. It took a couple of years for their good draft selections to bring Chicago the Stanley Cup but with Toews and Kane, they won the Cup in the 2009 – 2010, 2012 – 2013 and 2014 – 2015 seasons.
Drafting has become much more complex and quantitative since a young Bobby Orr was first spotted by a scout for the Bruins in Parry Sound, ON. Today, many teams compare every player available, based on analysis through a broad range of lenses to determine which are the best players available in each year’s draft. The goal is to not only use your first round pick most effectively but also to find hidden gems in the fourth or fifth round.
When Bobby Orr was selected, it was based on reports from scouts who spent every evening sipping coffee in arenas that could freeze you to the bone across Canada.
Investment management is following a similar path to building great hockey teams. There is a tremendous amount of information available to advisors to find potential all-stars for your investment portfolios.
One of the first things that a hockey general manager looks for when he is building his team is players who can light up a scoreboard. The equivalent to a highly skilled goal and assist leader is total return to investors. If I were to ask you to name the larger cap stocks (greater than $500 million market cap) with the highest total return to shareholders over the past 10-years, listed on the Toronto Stock Exchange, you might have a difficult time. You might name Royal Bank, Canada’s biggest company and you would have named the company with an annualized return of 10.11%, sitting in the number 62 position.
The top 5 companies are:
Download YCharts Reports
Boyd Group Charts Report
Constellation Charts Report
Computer Modelling Group Charts Report
ProMetric Life Sciences Charts Report
Open Text Charts Report
It is interesting that three of the five companies are listed in “Software – Application”. You could also add The Descartes Systems Group to that list, in the number 11 spot on the 10-year chart. I have attached YCharts multi-page reports for your convenience, which you can download by clicking on the company name above.
When was the right time to buy these companies? Like the old saying “When you had the money.”
The problem for most advisors is living with the fear that what goes up must come down and as you can see by the table above these companies have experienced drawdowns ranging from 20.2% to 48.9%. There were 116 companies on the Toronto Stock Exchange with market caps greater than $500 million that beat the TSX 60 over the past 10-years and the average 5-year drawdown was 46.2%, so most of this list not only beat the benchmark but also had lower drawdowns.
Maybe 10-years is too long for you so let’s look at the top 5-year scoring leaders:
Not much change. By the way, we left off Cynapsus Therapeutics because of a recent takeover/merger.
As a good GM, you are going to dig deeper than simply looking at shareholder performance. You may choose Constellation Software because it has the best 10-year EPS growth or Constellation or Open Text because they have the best ROE. You should also look at other factors such as ability to manage debt because you want your players to be strong in the defensive end of the rink.
We take a number of factors into consideration when building our “sandbox” of great companies. Unfortunately, Canada is a less developed country than our neighbor to the south and we have to be much more relaxed in our factors.
Our goal is to help our advisor clients is to build growth portfolios with Patrick Kane and Jonathan Toews-like companies in growth portfolio or more mature dividend paying companies in our income portfolios.
By the way, you don’t see too many cyclicals on the list of beating the TSX 60 over the past 10-years but the odd stock, like Torex Gold or Fortuna Silver, have made the top 50. Cyclicals may fill a spot for shorter-term timeframes but tend to trade sideways with volatility and may not make it into a growth portfolio for longer-term general managers.
When you build a portfolio, ask yourself the question “Would I rather have Jonathan Toews or Patrick Kane as the nucleus of your team or somebody learning to play in the AHL?” Too many advisors choose stocks that are either highly volatile, like the cyclicals and try to play the swings, buy stocks that are down thinking that there must be a profit opportunity on the horizon and avoid the proven winners because of the fear that what goes up must come down. That’s like saying that you should avoid Toews or Kane in the draft because they are likely to revert to becoming average.
For more details, watch today's Huddle recording below:
We have experienced a great bull market in bonds that has now lasted over 35 years.
Along the way, there have been some pretty significant corrections, like coming out of the stock market crash in 1988, 1994 and 1999. There was a pretty significant correction in 2009, following strong upward movement in bond prices when the stock market collapsed in 2008. When you look at this chart, the corrections seem very insignificant but if you lived through the corrections, that was not the case.
A simple indicator to helps us judged trends is the 200-day simple moving average. Price has been trading above the 200-day MA for most of the past 25 years. The chart below shows 20-year US Bond yields on a shorter scale.
You can see in this chart turned negative when we broke through a series of lows at just above $137.50. If we break through the MA, the next support level is $127.50. There is a strong chance that the moving average will hold as the slope is still quite strong. Moving averages are more easily broken when they have flattened.
If we take a longer-term view, we can see that there have been some pretty big declines following breaks of the moving average.
In previous posts, we have discussed the risk of longer-dated bond maturities. It is worth being careful at current levels.
Gold has been on an opposite path to Bonds over recent years but has had a strong move in 2016. Today, price has violated the 200-day MA. Often, when a security breaks on the upside, you will get a retracement back to the moving average to give you a second chance to buy. So, the red light is suggesting to keep a close eye on Gold to make sure that it can recover and resume an upward movement. To confirm the positive move in Gold, we need to break recent highs in the $1300 range. A break to the downside could lead to a retest of recent lows.
Impact On Equity Markets
The chart below shows the Earnings Yield for the S&P 500. Notice how Earnings Yields have declined significantly (from 7.5% to 4.2%)? If bond yields increase, you may see earnings yields on stocks increase, caused by lower stock prices.
We have become accustomed to stock and bond prices trading in opposite directions and large moves in bond prices when stock prices collapse, like in 2008. Correlations change over time and stock prices have recently been more correlated to bond prices.
This is not a time for panic. A red light simply signifies that there may be some trouble on the horizon and that you should act more conservatively and monitor bond, equity and precious metals markets more closely.
To view a recording of today's Huddle, click on the video below.