How we picked the stars

This year, an all-new ratings system made its debut for the Investor 500. Norm Rothery explains the method behind the magic in this Q&A.

CB Staff 0

It was 13 years ago that the first Investor 500 report from Canadian Business magazine hit the stands and it’s been a staple of retail investors ever since. Its breadth, combined with the plain-language distillation provided by accompanying features, makes it both authoritative and accessible. Over the years, there has been little need to change what is a winning formula—stock screens breaking down your best plays by various financial ratios, top analyst picks and our “Dogs of the TSX,” etc.—but for this iteration of the I-500 we’ve upped our game to bring you more  value.

Stock-picking expert Norm Rothery has lent Canadian Business his talents and provided an exclusive, proprietary ratings system for the list’s 500 stocks. It uses a momentum approach combined with some hallmarks of value investing to star the equities that comprise our best picks. Only 20 stocks passed the test of analysis to get five stars.

On this occasion, Canadian Business is for the first time offering up this research in the form of an e-book. One of the great advantages of this digital format is that it gives us space to ask more questions. We’ve tried to anticipate those you might have for Rothery and asked him to expand on what the new ratings system means for the I-500 and the retail investor.

Q: The top 50 stocks are heavily weighted toward the resource and financial sectors (approx 60%). Given Canada’s relatively “unilingual” investment palette in this sense, how should investors address the issue of diversification?
A: Diversification by sector and industry is difficult in Canada. Frankly, the best solution is to move beyond the Canadian market and to fill in any gaps in your portfolio with U.S. and international stocks.

Q: Curiously, only one of the 20 5-star rated stocks hails from either the resource or financial sector. What accounts for their domination among the top 50 but absence here?
A: To some degree it’s merely a matter of timing. However, we didn’t rate many junior resource stocks because they have trouble passing the value investing test most of the time. When it comes to financial firms, they have it easier on the value front. But most are simply lacking momentum of late. Mind you, several did pick up 4.5 stars, which is still pretty good all things considered.

Q: The methodology for the 5-star picks is informed partly by momentum investing and partly by value investing. Do these approaches contradict each other?
A: They are quite different techniques to be sure. But contradiction implies a close but opposite relationship. I prefer to think of them as more orthogonal to each other. They complement more than contradict.

For instance, if you look at the past performance of positive momentum stocks, you’d have done well to avoid those with the highest valuations. On the other hand, value stocks with negative momentum tend to lag other value stocks.

Q: It could be argued that in volatile economic times like these, beta is more important than ever. But it has been left out as a metric. Why?
A: It isn’t clear that beta has much explanatory power. If anything, low beta stocks have performed better than high beta stocks in contradiction to the Capital Asset Pricing Model. As a result, I prefer to use more direct technical techniques that have performed better over time.

Q: Can a typical retail investor working primarily with index funds or ETFs still benefit from the i500?
A: They can certainly use it for the non-index part of their portfolio but the I-500 is an active technique and I’d be loath to suggest it to diehard couch potato investors. But I think the I-500 provides a nice complement to more traditional index oriented portfolios.

Q: If there is a single piece of advice you can give an I-500 reader, what is it?
A: Think for yourself and to do more research each stock before buying. Be sure that a stock is right for you and your portfolio.

___________________________

Canadian Business prides itself in delivering the best investment information to our readers every year in the form of our Investor 500. This year the I-500 is available as an e-book for $3.99. In addition to our investment screens, stories and data-jammed tables, we are rating every single stock in the I-500 universe. Plus, we have chosen 20 stocks based on exclusive criteria that are rated tops in both momentum and value. We hope you find this year’s Investor 500 both interesting and profitable.

Click here for the Investor 500

Leave a comment

Your email address will not be published. Required fields are marked *