An investor’s search for quality stocks may go in many directions. But the most effective searches work with earnings and dividend growth, and often market price stability, as well.

Standard & Poor’s Corp. of New York offers one useful system for rating stocks by quality. Its list of top-ranked stocks is unusual because it has substantial Canadian content. For this reason, these stocks warrant consideration whenever an investor is scouring the market for top quality.

The top rank in the S&P ratings is, naturally, A+. Members of this group change gradually over time, and usually number between 60 and 90 stocks. In the most recent rating, there are 84 stocks rated A+, including these Canadian names:

> Bank of Montreal

> IGM Financial Inc.

> Loblaw Cos.

> Métro Inc.

> Power Corp. of Canada

> Power Financial Corp.

Five years ago, only two Canadian stocks made the list — Loblaw and IGM (then named Investors Group Inc.).

A significant feature of this list is, of course, the appearance of Power Corp. and its two major subsidiaries, Power Financial and IGM. The other significant feature is inclusion of two supermarket chains, Loblaw and Métro.

S&P is a leading bond-rating agency. Although bond ratings also offer a way to gauge quality of common stocks, not all companies have debt to rate. So S&P produces these separate earnings and dividend rankings for common stocks.

S&P uses per-share earnings and dividend changes over 10 years as the basis for assigning ratings. Among the factors considered in the calculations are stability and cyclicality.

The results, published in such S&P products as its monthly Stock Guide and Earnings Guide, covers more than 4,000 stocks. These include Canadian stocks that are dual-listed in the U.S. Not all have an alphabetic rating, because they lack the required 10-year history.

Stocks rated A+ generally maintain their high quality over time. Of the 70 stocks rated A+ five years ago, 34 still carry this rating. Of the remainder, 20 have dropped one step, to A (“high”). Another six have dropped two steps to A- (“above average”).

Only one stock has dropped to B+ (“average”), one has slumped to B (“below average”) and two have been downgraded to C (“lowest”). Six of the 70 no longer exist.

That is good experience, validating Standard & Poor’s assessment system.

The group of top-rated stocks from five years ago delivered above-average performance. Their total return (capital gains plus dividends) averaged an 8% gain, vs a 1.5% drop in total return of the S&P 500 composite index.

This occurred in a period in which small-cap stocks were particularly strong. Total return of the S&P small-cap index was an 11% gain in this period.

It’s no surprise, then, that a recent S&P list of stocks with the best five-year returns from 2000 to 2005 is almost entirely small-cap. These were mostly stocks that five years ago had no ratings or fell below S&P’s radar screen.

Of the stocks in the top-performance group for which 2000 rankings can be found, all had “B” ratings — either B+, B or B-.

This illustrates one feature of the S&P ratings: top-rated stocks deliver value and stability, but the best growth will probably come from stocks carrying lower ratings.

As a result, some U.S. money managers who use these S&P ratings tend to ignore the A+ stocks, and choose to buy stocks rated a step or two lower.

Despite this, the six Canadian stocks rated A+ hold interest for long-term investors, although most have lost rising momentum recently. After all, stocks’ past performance is the best — if imperfect — guide we have to their future performance.

In the market, only Métro and IGM continue to make gains. Over 12 months, Métro has gained as much as 70%, and it continues to outperform the S&P/TSX composite index.

IGM has a price gain over 12 months of better than 20%, but has merely matched the overall market’s performance if looked at since the beginning of 2002.

Bank of Montreal made strong gains in 2003, but since November 2003 has only matched the market.

Loblaw has had a long bull market, but recently dropped below a long-term moving average of its price. The stock has lagged the overall market since the autumn of 2002.

The pattern of Loblaw’s performance is echoed by both Power Corp. and its subsidiary, Power Financial. Both stocks have lost upward momentum; relative performance of both stocks has dropped heavily in recent months. Power Financial outperformed the market between 2000 and 2005, so it appears this long trend of outperformance has reversed.

@page_break@Métro’s big opportunity is its acquisition of the A&P supermarket chain in Ontario. Its return on equity for the fiscal year ended Sept. 24, 2004, was 21%, a five-year low. Valuation is historically high — trading at almost four times book value, the highest since 2002.

Loblaw’s return on equity has hit a ceiling at 20.5%, its level for the past three fiscal years. Recent valuations are historically mid-range, but the market values Loblaw higher than Métro on a price/sales basis. The two supermarket chains face price competition from superstore Wal-Mart Stores Inc. But Loblaw may also encounter competition at the high end of its product line with the entry into Ontario of the premium-price Whole Foods supermarket chain.

Bank of Montreal’s profitability has improved considerably since 2000, with return on equity reaching 20.6% in the fiscal year ended Oct. 31, 2004, from 15.4% in fiscal 2002. Its recent price/book valuation is in the mid-to-high historical range, but twice as high as it was at its 2000 low.

Profitability of Power Corp. and Power Financial has been irregular. In the past three years — for example, Power’s return on equity has ranged from 15.1% to 26.2% to 17.3% in the fiscal year ended Dec. 31, 2004. But profitability of subsidiary IGM as remained steady at around 21% return on equity. Price/

book value ratios for all three are in the historical high range. IE