What we are looking for:
U.S. large cap stocks that show growth & momentum characteristics.
Large cap stocks are often associated with slow and steady returns – and rightly so. Oftentimes larger companies with a stable background are better equipped to withstand turbulent market conditions and come back quicker after a market sell-off. With the turbulent markets we’ve been seeing lately and the potential for more volatility to come, seeking stability within your portfolio is an approach worth considering.
However, just because large cap stocks often exhibit stable characteristics, doesn’t mean they can’t also be used for a growth and/or momentum investor. Looking within the large cap universe, there are still a number of companies that have excellent growth potential and display positive upward momentum.
Today, my strategy searches for these growth and momentum stocks within the large cap U.S. stock universe. This strategy aims to capitalize on the upside while still being able to withstand volatility.
This strategy ranks stocks based on four factors:
- Quarterly earnings surprise – a measure of the difference between actual and expected quarterly earnings; high values are best.
- Quarterly earnings momentum – measured as the growth in most recent trailing 4 quarters earnings relative to the trailing 4 quarters earnings lagged by one month; high values are best.
- % Price change from 12-month high – a momentum factor; least-negative value is best.
- Forward return on equity (ROE) – a profitability metric; high values are best.
In order to qualify, stocks must have:
- Market cap in the top third of the universe relative to peers (this number today is $6.5B or higher).
- Quarterly earnings surprise greater than 0.
- Quarterly earnings momentum greater than 0.
- Forward ROE in the top half of the universe relative to peers (this number today is $13/share or higher).
- Five-year beta less than 1 to avoid stocks that are overly sensitive to changes in the S&P 500.
What we found
I used Morningstar CPMS to back test this strategy from December 1993 to February 2018. During this process, a maximum of 20 stocks were purchased. Stocks were sold if their quarterly earnings surprise dropped below -10%; if their quarterly earnings momentum dropped below -10%; or if their forward ROE dropped below the bottom third of the universe (this value today is $3.39/share or less). When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 15.4% while the S&P 500 Total Return Index returned 9.7% across the same period.
As can be seen in the following chart, annualized returns outperformed the benchmark across the longer terms time periods, such as the 5, 10, 15, and 20-year time periods. This resulted in an annualized outperformance of 5.7% across the full backtest period.
One last cautionary word is that the turnover for this strategy is fairly high at just over 100%. What that means is were you to follow this model, on average you would be selling and replacing all 20 stocks in your portfolio each year. Note that certain years can have higher turnover and others can have lower turnover as this is an average.
The 20 stocks that qualify for purchase today are listed below. As always, it is advised that investors conduct their own independent research before buying or selling any security.
|Rank||Company||Symbol||Market Cap ($ Millions)||Quarterly Earnings Surprise (%)||Quarterly Earnings Momentum (%)||5-Year Beta||Price Change Relative to 12M High (%)||Forward ROE ($/share)|
|1||Broadridge Fin Sol Inc||BR||12373.51||28.75||12.00||0.93||-0.64||47.81|
|6||Estee Lauder Cos Inc||EL||52794.42||3.46||7.79||0.70||-0.22||41.59|
|8||Michael Kors Holding||KORS||9378.69||36.72||2.88||0.15||-11.84||35.22|
|9||Yum! Brands Inc||YUM||27069.89||12.90||5.70||0.74||-6.35||32700.00|
|11||Brown Forman Corp CL B||BF.B||25409.52||17.65||6.77||0.88||-6.90||53.67|
|13||Southern Copper Corp.||SCCO||42369.69||0.54||24.03||0.50||-1.28||33.61|
|17||TJX Companies Inc||TJX||52247.15||1.81||7.30||0.66||-2.55||59.81|
|18||HCA Holdings, Inc.||HCA||35448.74||6.45||3.66||0.46||-5.18||87200.01|
Emily Halverson-Duncan is an Account Manager with Morningstar Research Inc., which 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.
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