Friday, 2 November 2012

Socially Responsible Stocks – Which ones are the solid money makers?

Last week we looked at the performance of ETFs holding a basket of stocks that meet the criteria of being Socially Responsible (SRI). The track record and the academic research suggest SRI stocks in combination on average get about the same returns as a benchmark cap-weight index. That's enough to satisfy one's conscience perhaps, but suppose we seek better returns. Can we avoid the duds and pick only the best stocks?

Defining what "Best" means ...
This week we drill down into the Canadian SRI stocks to see which ones look to be the best, in terms of:
a) consistent company performance plus
b) solid stock returns 
c) the most attractive value at the moment
d) considering also the desirability of low volatility and healthy growing dividends.

Narrowing Down the Canadian SRI Stock Universe
We start with all 71 Canadian stocks that pass screening for SRI criteria in two ETFs - iShares Jantzi Social Index fund (TSX:XEN) and Pax MSCI North America ESG Index ETF (NYSE: NASI). To get a table with lots of useful data, we plugged all 71 stock symbols into the Globe WatchList and then used its handy export feature to download the data into a spreadsheet on our PC for further sorting and entering additional data.

Step 1 - Consistent profitability - First hurdle for the stocks to pass - how many years out of the last five has the company made positive earnings. Our minimum is at least 4 out of 5 and no loss in the most recent financial year or trailing twelve months. Right away, we drop several companies with a negative return on equity (ROE) in the past year i.e. ROE can only be negative if the return/earnings are negative. Unfortunately, the WatchList table doesn't include ROE for the past five years so we had to look elsewhere. To do this, ADVFN's company information under the Financials tab (e.g. for Bank of Nova Scotia) has a nice graph of five-year ROE. For a handful of the stocks in our table, ADVFN doesn't have any data so we turned to TMX Money and the Financials/Income page for the stock to see the net income for the past five years (e.g. here for Pacific Rubiales Energy). Goodbye to a bunch more stocks (like Westport Innovations which hasn't made any profits in the last five years).

Step 2 - Dividends growing - Any company that cut its dividend, or failed to increase it at all during the past five years, we also deleted. We left one company in our list that had no increase - CGI Group - since it has a policy of not paying a dividend but it has been increasing earnings per share at a very healthy and steady pace over the five years. In several cases we had to clarify and correct data in the WatchList download by referring to TMX Money or to, which gives easy quick access to dividend data.

Step 3 - Healthy fundamentals - Companies that had very low return on equity (under 10%), poor operating margin or high debt to equity ratio, also got deleted.

Step 4 - Reasonable stock returns - Companies with much poorer returns than two benchmarks - the XEN fund itself, or the iShares S&P/TSX 60 Index (TSX: XIU) - were removed. However, we did not set a strict cut-off since negative market sentiment that has caused stock price declines might well be reversed, especially when company fundamentals are sound. This dovetails into the last step, judging reasonable stock value.

Step 5 - Attractive stock valuation - The starting point measure of an attractive stock price is the price to earnings ratio (P/E), the lower P/E the better, other things being equal. We therefore eliminated stocks with P/E over the XIU benchmark figure of 18.3. It is thanks to BMO Investorline's (client access only) ETF Compare tool that we were able to obtain the P/E and price-to-book figures for XIU and XEN.

Beta, a measure of volatility, was also taken into account, with values under XIU's 1.0 being a plus. We allowed Potash Corp to stay in despite its very high beta of 7.4 due to compensating factors like very high ROE, operating margin and dividend growth rate with a quite low P/E.

Finally, we note the investment firm analyst ratings (keeping in mind the caveats of such), the majority being "Hold", and any insider buying or selling activity (recent data from TMX here; see also our post on why this can matter here)

The Solid SRI Stocks
We do not pretend that every one of the 27 stocks in the results table below will be a winner. Past performance is only a guide, not a guarantee. But we believe most will do well. Nor do we think there are many blockbuster winners. Our method has directed us to the steady solid performers. That would perhaps be enough to satisfy most investors, both in their pocketbook and in their conscience.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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