What are we looking for?
Canadian companies that show strong cash flow.
The screen
While there are a lot of different ways to evaluate stocks, cash flow remains one of the most popular among investors. The more excess cash a company has available, the better their ability to undertake projects to grow business, pay off debt and/or increase dividends to shareholders. Any one of these activities is a positive indication that a company could be a good investment.
Today, I'm showcasing a strategy that looks for Canadian companies that have excess cash flow at their disposal. The strategy ranks stocks based on:
- annual cash-flow momentum (measures the rate of change of annual cash flow per share; high values are best);
- five-year cash flow growth (annualized, high values are best);
- latest four quarters’ cash flow per share (high values are best).
In order to qualify for purchase into the portfolio, stocks were required to have annual cash-flow momentum, five-year cash flow growth and their latest four quarters of cash flow to have positive values. They were also required to have their five-year beta (measure of a company's sensitivity relative to changes in the benchmark – here we use the S&P/TSX composite index) less than 1.0. Lastly, each stock was required to have the gap between its current price and its 200-day moving average to be greater than 3 per cent (a technical indicator).
More about Morningstar
Morningstar Research Inc. 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.
What we found
I used Morningstar CPMS to back test this strategy from February, 1999, to December, 2017.
During this process, a maximum of 15 stocks were purchased. Stocks were sold if their annual cash flow momentum, five-year cash flow growth, or latest four quarters cash flow were below zero. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 18.3 per cent while the S&P/TSX composite total return index gained 7.7 per cent across the same period. It's also worthwhile to note that, in all quarters over this period spanning almost 19 years, where the index showed negative returns our strategy beat the benchmark 80 per cent of the time.
Stocks that qualify for purchase into the strategy today are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.