Screening for top U.S. stock prospects in 2018

What a rally it’s been. In calendar 2017, the S&P 500 Total Return index produced a whopping 21.8 per cent return with positive gains in all sectors except Energy and Telecommunications. Even though the US market has looked overvalued for multiple years, US equities continue to provide spectacular returns to investors.

For investors bullish on the US economy, the following growth-oriented strategy may offer some ideas. To develop this strategy, I used Morningstar CPMS to first rank stocks in the S&P 500 index on the following factors:

High Return on Invested Capital (A profitability metric that measures pre-tax Earnings per Share divided by the average debt and equity over the same reporting period)
High 5Y EPS Growth Rate (on average, by how much did EPS grow by each year in the last 5 years)
Positive 3M Estimate Revision (Today’s EPS consensus estimate versus the same figure 3 months ago)
Positive Price Change from Month End, 3 and 9 months ago
Low Enterprise Value / EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization)

To qualify for purchase, a company’s Debt to Equity ratio must be in line or lower than the median of the sector to which it belongs and the stock must be ranked in the top 25% of stocks in the index based on the above five factors.

What we found

I used Morningstar CPMS to back test this strategy from April 2004, to December 2017. During this process, 20 stocks were purchased and equally weighted with a maximum of four stocks per economic sector. Once a month, we sell any stocks that rank below the top 35% of the S&P500 based on the above factors or if the company missed earnings expectations by more than 5%. When this happened, we would sell the stock and replace it with the highest ranked stock not already in our portfolio. Over this period, the strategy produced an annualized total return of 12.8% while the S&P 500 Total Return Index produced 8.9%. In calendar year 2017, this strategy produced a 29.9% return.

The below table shows a clear picture of how such a strategy performed in trailing periods:

Additionally, the return distribution of the portfolio are shown here:

The stocks that qualify for purchase into the strategy today are listed in the table below. As always, it is advised that investors conduct their own independent research before buying or selling any security.

Rank	Symbol	Company	Morningstar Sector	Market Cap ($USD Millions)	Return on Invested Capital (%)	5Y EPS Growth Rate (%)	3M Estimate Revision (%)	Enterprise Value/EBITDA	Debt to Equity Relative to Sector Median*	Price Change from Month End 9 Months Ago (%)	Price change from Month End 3 Months Ago (%)	Latest Earnings Surprise (%)	Dividend Yield (%)	Close Price as of January 18th, 2018 ($USD/Share)
1	MU	Micron Technology Inc	Technology	50908.73	29.49	113.18	33.81	4.23	0.65	58.98	-0.72	8.52	0	43.99
2	KORS	Michael Kors Holding	Consumer Cyclical	9886.63	38.24	17.56	9.32	9.36	0	74.15	33.19	20.06	0	65.01
3	ROST	Ross Stores Inc	Consumer Cyclical	31202.22	46.52	12.94	2.59	13.81	0.17	25.62	28.6	3.9	0.78	81.65
4	NVDA	NVIDIA Corporation	Technology	134664	40.19	60.55	19.23	45.9	0.62	115.19	8.52	14.47	0.27	224.44
5	TGT	Target Corporation	Consumer Defensive	42344.3	11.19	5.94	22.67	7.67	1.05	39.48	31.94	3.69	3.18	77.9
6	TXN	Texas Instruments Inc	Technology	114729.12	32.11	22.98	0.11	16.56	0.56	47.02	20.4	5.47	2.13	116.41
7	BIIB	Biogen	Healthcare	72841.1	26.46	31.1	1.12	10.68	0.79	27	10.52	3.63	0	344.44
8	LRCX	Lam Research Corp	Technology	33271.85	25.36	50.49	0.9	13.47	0.49	41.84	-1.5	2.04	0.97	205.45
9	LUV	Southwest Airlines Co	Industrials	38605.79	13.13	56.41	5.49	9.03	0.43	15.72	20.79	1.04	0.77	65.06
10	TSCO	Tractor Supply Co	Consumer Cyclical	10158.16	21.03	12.51	3.67	12.88	0.46	30.67	34.25	2.04	1.34	80.9
11	GPS	Gap Inc	Consumer Cyclical	13127.81	19.9	-5.69	3.26	7.29	0.5	28.86	29.9	3.46	2.73	33.76
12	PAYX	Paychex Inc	Industrials	24751.47	40.61	9.02	0.21	17.3	0	16.24	8.03	0.36	2.9	68.91
13	AMG	Affiliated Managers Grp	Financial Services	11412.08	15.91	10.38	4.57	8.48	0.83	23.99	10.09	0.5	0.39	205.32
14	HUM	Humana Inc	Healthcare	39920.83	22.52	6.69	0.2	9.71	0.61	25.89	9.43	2.51	0.57	279.44
15	CBG	CBRE Group, Inc.	Real Estate	15340.16	12.54	18.68	4.35	10.18	0.7	26.19	14.93	5.79	0	45.19
16	VLO	Valero Energy Corp	Energy	42209.1	6.28	-2.76	13.31	8.8	0.72	49.3	22.27	1.55	2.9	96.46
17	EXPD	Expeditors Intl of Wash	Industrials	11744.38	26.61	10.39	3.14	16.08	0	17.83	13.21	3.67	1.27	66.09
18	CHRW	CH Robinson Worldwide	Industrials	13059.49	17.92	7.48	9.03	17.05	0.73	28.86	19.29	0.07	1.96	93.68
19	AET	Aetna Inc	Healthcare	60488.29	11.89	12.73	0.99	10.54	0.89	37.33	9.09	5.32	1.08	185.49
20	ALGN	Align Technology Inc	Healthcare	21704.1	30.23	19.61	2.31	63.65	0	101.08	13.27	8.22	0	270.7

*Note that a figure of 0.65 in this column implies that the company’s Debt/Equity Ratio is 35% lower than the median of the sector.
Data as of January 18th, 2018
Source: Morningstar CPMS

More about Morningstar
Ian Tam, CFA, is an analyst 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. 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.