What are we looking for?
Given the impact of inflation, companies may report solid sales, but also disappointing profit margins. To address this issue, we aim to identify businesses capable of transferring the entire impact of inflation to consumers by increasing prices, consequently increasing company sales and economic profits. (Economic profit is defined as a company’s net income minus opportunity cost. Opportunity cost refers to the value of the best alternative foregone when the company chooses a particular course of action.)
The screen
We screened stocks from the S&P/TSX Composite Index using the following criteria:
- One-year sales growth greater than 8 per cent. We want a company enjoying the effect of inflation on its sales;
- Three-month economic value profit (EVA) greater than 5 per cent. This is our economic profit metric;
- Five-year return on capital greater than 10 per cent. We look for companies with robust long-term earnings potential;
- Price-to-earnings ratio lower than 20. We don’t want to pay too much for a company’s profits.
For informational purposes, we have also included market capitalization, one-year price performance and dividend yield. Please note that some ratios may be shown as of the end of the previous quarter.
More about Inovestor
Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios and easily communicate investment decisions with clients through client-friendly reports.
What we found
Parex Resources Inc. is an oil and gas exploration and production company that operates primarily in Colombia. With a five-year return on capital of 23.5 per cent, it has shown extremely robust financial performance over that period. The company has experienced massive EVA growth of 729 per cent over the past three months. Parex’s stock price has been more volatile recently due to tax reforms in Columbia targeting oil and gas companies, resulting in a potential tax increase. Parex trades at a price-to-earnings ratio of 3.9, the lowest of our screen.
Definity Financial Corp. is a property and casualty insurance company that began trading on the TSX in late 2021. The company’s three-year average return on capital stands at 10.9 per cent; the calculation is possible because partial financial statements for 2020 and 2021 became available. With three-month EVA growth of 234.4 per cent, it could be worth keeping an eye on this newly listed company.
Pason Systems Inc. is a supplier of drilling rig instrumentation and data management systems. The company has increased its sales by 50.4 per cent over the past year. This may be attributed to the energy sector’s increased production, a consequence of higher oil prices. Despite this growth, Pason Systems’ price-to-earnings ratio remains relatively low at 8.5, indicating that the market may not fully recognize the company’s potential for growth or that investors may view the energy sector’s strong performance as temporary.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
For more details about these stocks, subscribe to the Inovestor for Advisors platform for free.
Anthony Ménard, CFA, is vice-president of data management at Inovestor.
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