What are we looking for?
Free cash flow serves as a key indicator of long-term sustainability by providing insight into a company’s ability to acquire other companies, repay debts and distribute dividends.
Today, our focus will be on identifying companies that generate significant free cash flow while they effectively manage value creation and growth.
The screen
We screened Canadian stocks focusing on the following criteria:
- One-year and five-year average ratio of free cash flow to capital greater than 4 per cent. We look for companies with solid current and historical free cash flow metrics;
- Relative economic performance index (relative EPI) greater than 0.8. Relative EPI is a multistep calculation that compares the profitability of a company with its valuation and cost of capital. Higher profitability, a lower valuation and a lower cost of capital each increase the ratio;
- Positive three-month net operating profit after taxes (NOPAT) growth. We want to avoid companies that experienced a decline in their operations in the most recent quarter;
Due to the unique nature of the free cash flow metric of financial companies, we decided to exclude them from our screen.
For informational purposes, we have also included three-month sales growth, one-year share price performance and dividend yield. Please note that some ratios may be shown as of the end of the previous quarter.
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What we found
North West Company Inc. NWC-T holds a prominent position as a retail provider in underserved markets in rural and urban areas. The company exhibits a remarkable five-year ratio of average free cash flow to capital of 10.3 per cent, which stands as the highest among our list, indicating efficient capital allocation and robust operating flexibility. Furthermore, NWC has demonstrated positive growth momentum, evident from its respectable three-month NOPAT growth of 7.1 per cent.
Torex Gold Resources Inc., TXG-T the second-largest gold producer in Mexico, has undergone remarkable expansion with a substantial three-month NOPAT growth of 19.9 per cent. Moreover, its relative EPI of 1.3 indicates solid profitability when adjusted for valuation and risks. These solid metrics are further reinforced by the impressive 57.7 per cent increase in share price over the past year, reflecting favourable market sentiment toward the company.
Telus International Inc., TIXT-T a subsidiary of Telus Corp., has established itself as a prominent global provider of customer experience and digital solutions. Recently, the company made significant strides in expanding its operations through the acquisition of WillowTree. This strategic move not only broadens Telus International’s client base, but also bolsters its continuing digital transformation initiatives. Surprisingly, despite the rebound of the information technology sector over the past year, Telus International has been somewhat overlooked by investors, experiencing a notable share price decline of 33.4 per cent.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
Anthony Ménard, CFA, is vice-president of data management at Inovestor.
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Anthony Ménard, CFA