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The Globe 250

We're pleased to present our new Megastar ranking of Canada's largest publicly traded companies. It provides key investing data on 250 major stocks. Each one is analyzed and awarded two star ratings - one for its appeal to value investors and the other for its allure to momentum investors. We then combine value and momentum to select 20 Megastar stocks for the best of both worlds.

The idea is to deliver the information that investors desire and use numerical analysis to highlight stocks that might deserve a spot in your portfolio.

Our star system combines two schools of investing with pedigrees that stretch back decades and that have been quite profitable in recent times. It starts with value investing principles, which favour profitable companies that trade at low prices relative to their fundamentals. Our system also employs techniques used by momentum investors, who like to buy recent winners.

Stocks are ranked for their value and momentum appeal. But the rankings are based entirely on the numbers. The number of stars does not reflect the character of a company, its management or its employees. The stock of a very meritorious business may get a low number of momentum stars if that company and its sector are in a temporary downtrend.

We believe our star system offers an objective take on the largest 250 common stocks on the TSX with at least 12 months worth of trading history. We also try to skip over firms that are in the process of being purchased by another company, such as Shaw Communications Inc. this year, because they are usually in the purview of merger arbitrageurs.

We hope you enjoy this year's Megastars and you can learn about the star system below.

Awarding Value Stars

Value investors are bargain hunters at heart. Our analysis starts with a company's bottom line by rewarding stocks that have low price-to-earnings ratios (P/E). It's a classic value-investing approach that identifies profitable firms trading at relatively low prices.

Bargain hunters also like solid stocks selling at low prices relative to their net worth. That's why we favour companies with low price-to-book-value ratios (P/B). This ratio compares a firm's market value to the amount it could theoretically raise by selling its assets at their balance-sheet values and paying off its debts. A low P/B ratio provides some assurance you're buying a company at a discount.

In addition, we want to make sure that companies use their capital wisely. So, we track each stock's return on equity (ROE), which measures how much a firm is earning compared to the amount its shareholders have invested. ROE is a common measure of business quality.

We also appreciate companies that have enough money to buy back their own shares and that have cut their share counts significantly over the past four quarters. After all, a well-executed repurchase program can add a huge amount of value when firms trade at bargain prices.

The value factors are combined to determine each stock's value star grade, and the top 10 per cent (or 25 stocks) get a full five out of five stars.

In a back-test, the five-star value portfolio gained an average of 15.6 per cent annually from the end of 1999 through to the end of November, 2022, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly.

In comparison, the S&P/TSX Composite Index (a reasonable proxy for the Canadian stock market) gained an average of 6.7 per cent annually over the 1999 to 2022 period. (Our data comes from Bloomberg. All the returns include dividend reinvestment, but not fund fees, taxes, inflation, commissions and other trading costs.)

Value stocks can usually be held for months - and sometimes years. When rebalanced annually, the five-star value portfolio gained an average of 16.1 per cent annually from the end of 1999 to the end of 2021. The market index climbed by an average of 7 per cent a year.

Gaining Momentum Stars

Momentum investors love to buy stocks on the upswing because they have a habit of continuing to climb. Early this year, for example, the oil and gas sector did well for months. Conversely, stocks on the decline tend to continue to slide, at least in the short term.

While it might seem to be overly simplistic, buying based on momentum has been profitable in nearly every stock market in the world for decades, and in some cases centuries.

We take a blended approach with momentum, and combine results from several different periods. We favour stocks that have performed well, compared to their peers, over the past three, six and 12 months.

In addition, we prefer steady returns and shy away from highly-volatile stocks. The idea is to avoid stocks that might act like lottery tickets, because they often fail to compensate investors for the risks they involve.

The momentum factors are blended to determine a star grade for each stock, with the top 10 per cent (or 25 stocks) getting a full five out of five stars.

The five-star momentum portfolio gained an average of 15.8 per cent annually from the end of 1999 through to the end of November, 2022 when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. In comparison, the S&P/TSX Composite Index gained an average of 6.7 per cent a year.

Momentum stocks often fare well with short holding periods and the five-star momentum portfolio was no exception. It gained an average of 12 per cent annually from the end of 1999 to the end of 2021 when it was rebalanced annually instead of monthly. In comparison, the market index climbed by an average of 7 per cent a year.

The Megastar Team

There are several different ways to merge value with momentum. One way is to split a portfolio in half and put one part into the five-star value stocks and the other into the five-star momentum stocks. But keeping up with a 50-stock portfolio can be overwhelming. We focus instead on the 20 stocks with the best blend of value and momentum characteristics, which form our Megastar team.

The 20-stock Megastar portfolio provided average annual returns of 14.3 per cent from the end of 1999 to the end of November, 2022, when an equal-dollar amount was put into each stock and the portfolio rebalanced monthly. It gained an average of 13.1 per cent from the end of 1999 to the end of 2021 when rebalanced annually.

The Megastar portfolio is roughly a fifth less volatile, on average, than either the five-star momentum or five-star value portfolios in the back-tests. We believe most investors benefit by exchanging slightly lower expected returns for much lower volatility. With a little luck, the Megastar team will deliver strong results while allowing investors to sleep better.

Sense and Sensibility

While the Megastars and our full ranking represent a great starting point for further research, you should improve your understanding of each company by studying it and its industry in more detail.

Watch your step, as well, with stocks that trade infrequently, and those with very low share prices, because they may be difficult to buy or sell in a cost-effective manner.

Before dashing off to the market also recognize the built-in limitations of quantitative methods such as ours, because less tangible factors can be important. The quality of a company's management can sometimes help - or hinder - a business.

And while we hope our portfolios achieve similar returns to those in the back-tests, the market isn't that predictable. Even in the best circumstances, we expect results to be bumpy and some individual stocks will disappoint. We would be pleased indeed for the portfolios to outperform the market index by an average of a few percentage points a year over the next couple of decades. (For the sake of disclosure, the author owns many of the stocks mentioned herein.)

Enjoy looking up the facts and figures that mean the most to you. After all, the purpose of our star system is to help guide you through the market to stocks you might want for your portfolio.

Megastar Article: The 20 Megastars
Spreadsheet: The Top 250 Value and Momentum Star Rankings [.xls]

First published in the Globe and Mail, December 9 2022.

 
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