With market sentiment really high and a lot of investor attention on SPACs and EV stocks, it’s important to remember that more speculative investments come at a cost: Higher potential volatility.

While there’s no denying the growth potential behind some of these high growth themes, we’ve seen stocks (even with good growth stories) fall as much as 50% or more, just from a change in market sentiment.

Given the current environment, we thought it would be a good idea to turn to a good old-fashioned quality screen for our monthly 5i stock screener. This month’s screen focuses on companies with value, quality and growth characteristics that investors can consider for their portfolios.

To keep things simple, we have set out three main fundamental criteria, each corresponding to a either quality, value or growth characteristics. This combination aims to find companies with both attractive upside potential and downside protection in the case of a change in market sentiment.  

Here are the criteria:

Quality: Debt to Equity below 50%

While this is only one of many metrics one can use to filter for quality, we think it fits well in this mix and contributes to finding companies with some downside protection. Companies with lighter debt loads are less likely to be scrutinized if interest rates rise, are more likely to have more room to borrow if needed and due to lower debt obligations they tend to have greater free cash flows (all things held constant) to reinvest into the business or cover unexpected expenses.

Value: P/E below 16 

With the average forward P/E ratio for the TSX being around 16x, setting the criteria for stocks with a forward ratio below this is a good way to quickly find companies that may be undervalued compared to the overall market. Of course, we do not believe there is a silver bullet when it comes to valuation as the ‘right’ multiple will vary by industry and from company to company. However, we think for the purposes of this general screen of the Canadian market, it is appropriate for filtering out some expensive, more volatile stocks and identifying stocks that may have flown under the radar.

Growth: Positive annual earnings growth over the last three years

We left the criteria here a bit loose but for good reason. The resulting screen still only ended up with about 27 stocks. Considering COVID’s impact to earnings over the last year, for a company to still show positive annual growth in earnings over the last three years is actually impressive and a good indicator of a company’s financial health, cost management and even business model.

You can view the screen below:

Mining for quality 

With commodities expected to do well given higher inflation expected and a weaker USD, metals and mining stock have had a solid run and for the right reasons: the economics are improving. Readers may notice a large portion of this list is in metals and mining and we think the criteria set above are a good way to find companies that have lower downside risk in a sector that is sensitive to external factors (interest rates, lower inflation etc). Good balance sheets, lower valuation multiples and positive earnings growth are a good starting point when looking for names in this sector.

Insurance companies 

This screen also resulted in a lot of insurance companies (and no banks). With an expected economic recovery, the insurance sector tends to do well with more economic activity (more things need to be insured). While an eventual rise in interest rates will positively contribute to profitability given substantial investment in interest-based assets, insurance company margins are not as sensitive to interest rates compared to banks. Until rates do rise, insurance companies can make for a good alternative for financial sector exposure. Sunlife Financial (SLF) continues to be one of our favourites in the sector with its strong market position. The stock has almost fully recovered on a one-year basis and has actually been able to continue growing revenues on a year-year basis even throughout the pandemic. The company also pays a decent dividend yield 3.5%.

Photon Control (PHO)

One of the things we like about screens is the opportunity to find small quality names with growth potential. A notable small-cap name that we like at 5i Research is Photon Control (PHO). PHO checks off a lot of boxes that we look for: strong revenue growth (29% five-year CAGR), earnings growth (32% three-year CAGR), low debt (3% of equity), high ROE of 15% and an attractive forward price-to-earnings multiple of 14x. This makes PHO stands out to other names on this screen on fundamentals and valuation. The stock is up 70% over the last year and up 13% this year so far and we think there is still room for upside based on current multiples. With strength in the semiconductor space and high cash balance, the outlook should be decent for PHO over the next few years.

While we are not endorsing any particular company on this list, we think this is a good place to start for investors looking for exposure to companies that show sound investment characteristics and good value.

Take care and remember, do your research.

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Disclosure: Employees of 5i Research involved in the research process cannot trade in Canadian traded stocks and do not hold a financial interest in Canadian companies mentioned.