What are we looking for?
Following the recent drop in the markets, many investors are looking to invest in safer companies, such as blue chips with steady cash flows; they have less of an appetite for companies trading at a high premium or depending heavily on future growth. Today, by evaluating economic performance, we are searching for defensive yet wealth-creating stocks that can resist a downward pressure.
The screen
Our search for less-risky Canadian large caps used the following metrics:
- A market capitalization of $1-billion or above;
- A future-growth-value-to-market-value ratio between minus 60 per cent and 30 per cent. Ideally, we are looking for a negative FGV/MV as this translates into a discounted stock. (This metric represents the proportion of the market value of the company that is made up of future growth expectations.) A positive number shows the stock is trading at a premium, thus, making the stock riskier. On the other hand, a negative FGV/MV reflects a current discount;
- Return on capital equal to or greater than 10 per cent;
- Free-cash-flow-to-capital ratio greater than 5 per cent. This ratio gives us an idea of how efficient the company converts its invested capital to free cash flows, which is the amount left after all capital expenditures have been accounted for. It is an important measure as it gives us the company’s financial capacity to pay dividends, reduce debt and pursue growth opportunities. We are looking for a positive ratio;
- Economic performance index (EPI) above one. This is a key criterion as it calculates the return on capital to cost of capital. EPI above one indicates that the company is generating wealth for the shareholders – for every dollar invested into the company, more than a dollar is generated in returns;
- Beta of less than one. Stocks with beta below this threshold tend to move less than the index in trending markets, making them less volatile.
More about Inovestor
Inovestor for Advisers is a fundamental analysis application based on the economic value-added (EVA) approach. It aids advisers in quickly identifying attractive investment opportunities and easily communicating them to their clients. In addition to providing detailed reports on more than 13,000 companies (Canadian stocks, U.S. stocks and American depositary receipts), Inovestor allows investors to create personalized filters and build custom portfolios.
What we found
Over all, the results are not surprising as all those Canadian companies have generated annual positive revenue growth for at least the past three years. Out of the 14 wealth-creating companies, four are currently trading at a discount reflected by a negative future-growth-value-to-market-value: CCL Industries Inc., Transcontinental Inc., BCE Inc. and New Flyer Industries Inc.
CCL Industries, a Toronto-based specialty packaging company, possesses an impressive economic performance index of 3.6. It is important to note that CCL has undergone a continuous growth in return on equity over the past five years even if its debt-to-assets ratio has increased in the past three years (not shown). The company managed to expose shareholders to a 20-per-cent growth in EPS over that same period. The company's earnings per share grew 20 per cent, cumulatively, over the same period.
Another interesting result is FirstService Corp., a residential property management company. FirstService is currently trading at a premium, however, it has experienced growth in its economic performance index since it has gone public and the overall EVA is still on an upward trend.
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Noor Hussain is an account executive for Inovestor Inc.