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Phil Dabo: Welcome to Quant Concepts' working from home edition. We've seen a lot of volatility in markets this year with a lot of uncertainty around corporate and economic performance. At the beginning of the year until March 23rd, we saw the S&P/TSX down approximately 34%. From there until late August, we saw a really good bounce back in performance with momentum driving performance on the S&P/TSX to return approximately 49%.
Today, let's take a look at a momentum strategy and see if we can identify some of those top names that are contributing to performance on the S&P/TSX. Let's start by ranking our universe of around 700 stocks.
In the ranking step, we're going to look at four main factors, which you can see here. The first factor is the quarterly earnings surprise, which is a proprietary measure of the difference between actual and expected earnings for the latest quarter, and we want stocks that are consistently beating analysts' expectations. The next factor is the three-month earnings revision, which measures the change in the past three months in the median earnings estimate for the fiscal year. Essentially, we would like to see companies consistently beating analysts' expectations. The next factor is the quarterly earnings momentum factor, which is based on what the company actually reported. And finally, we're going to have a factor to reduce the volatility in reported earnings, which can be accomplished using the earnings variability of historic EPS.
Now, let's run the screening process. As you can see here, we're only going to select stocks that rank in the top 25th percentile of our list. We're going to exclude companies that are not in the top 8th percentile by market cap float. And we also want to select stocks that rank highly according to forecasted earnings per share and we will exclude stocks that are in the bottom third of our list according to forecasted EPS next quarter.
Next, let's take a look at our sell rules. In this case, we've kept things very simple with only one sell rule. And that sell rule is going to exclude stocks that are in the bottom 30th percentile of our list.
Now, let's take a look at our back test page. In our back test, we've started the period from January 1993, and we've run it until September 2020. Over that time period, we've seen very good outperformance, with 11.8%, which is 3.3% higher than the benchmark, with only 22% annualized turnover, which indicates that this is a very good buy and hold strategy.
Taking a look at standard deviation, which is here, we can see that there has been lower standard deviation of returns across every significant time period. This contributes to really good risk-adjusted returns as measured by the Sharpe Ratio, and we can also see that it has outperformed the benchmark over every significant time period. We can also see that this strategy has had lower beta over every significant time period. That reduces market risk and we can also see significant alpha generated from the strategy.
As mentioned before, we've seen really good outperformance since '93, but more importantly, over the past 10 years, we've seen very good outperformance, and we've seen very good bounce back in performance here at the end over the past six months since April.
I also like to take a look at market capture ratios. We can see that this strategy has a very good downside capture ratio which has contributed well to the overall market capture ratio since 1993.
Finally, let's take a look at the buy list of 20 stocks. We can see from this list that 7 of the top 10 stocks that contributed positive returns to the S&P/TSX are also included on this buy list. You can find the buy list accompanying the transcript of this video.
From Morningstar, I'm Phil Dabo.
