The Toronto Stock Exchange on Bay Street on March 23, 2009.CHRIS YOUNG/The Canadian Press
Summer is here and it’s time to hightail it to the beach with a little spending money.
To generate a few coins, investors might turn to the U.S. stocks in the Free Cash portfolio, which has been a big money-maker. But Canadians who want to stick closer to home can employ the same bargain-hunting technique here.
In the United States, the Free Cash portfolio gained an average of 14.9 per cent annually from the end of 1999 to the end of 2022, during which time it was rebalanced once a year. The Canadian version sported solid average returns of 11.6 per cent annually over the same period while the market index (the S&P/TSX Composite Index) climbed by an average of 6.4 per cent annually. (All of the returns herein are based on data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The Canadian version of the Free Cash portfolio starts with the largest 300 common stocks on the Toronto Stock Exchange and picks the 10 with the lowest enterprise-value to free-cash-flow ratios. An equal amount of money is invested in each stock and the portfolio is rebalanced annually or monthly.
Enterprise value (EV), simply stated, is equal to a firm’s market capitalization plus its net debt. Free cash flow (FCF) is theoretically the amount of money a company can distribute to its shareholders while maintaining its operations. In this case, it is approximated by subtracting capital expenditures from cash flow generated by operations.
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The Canadian Free Cash portfolio climbed by an average of 14.5 per cent annually from the end of 1999 through to the end of May, 2023, and was rebalanced monthly. Meanwhile, the market index gained an average of 6.4 per cent a year over the same period. You can examine the performance record of both in the first accompanying graph.
The portfolio’s strong returns are grand, but investors will discover that, much like picnic-destroying thunderstorms, they come with risk in the form of more than a little volatility. Alas, the portfolio plunged dramatically four times over the past 23 years. As a result, the cash it generates isn’t free – of worry or risk.
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The second graph highlights bad periods for both the portfolio and market index by showing how far they fell, as a fraction of their prior peaks, in downturns. The portfolio suffered from four declines of more than 20 per cent since the start of 2000 (based on monthly data), while the market index ran into three such calamities.
For instance, the market index declined badly after the internet bubble burst in the summer of 2000 with a crash of 43 per cent into the fall of 2002. On the other hand, the portfolio held up fairly well with a decline of 22 per cent.
Another big bust happened during the financial crisis when the market index tumbled 43 per cent into early 2009 while the portfolio plummeted 58 per cent. Mind you, the portfolio recovered to its former highs almost a year before the market index did.
The Canadian Free Cash portfolio weakened again after a peak in 2011 with a decline of 30 per cent while the market index sank 17 per cent.
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The pandemic crash of 2020 extended a bad multiyear streak for the portfolio with a 41-per-cent decline, while the market barely made it into bear market territory with a brief slip of 22 per cent.
I think the Canadian Free Cash portfolio will likely continue to perform well over the long term. But it’s not for passive souls who’d rather be sitting on the beach sipping a bubbly beverage than worrying about actively managing their money.
You can find the stocks in the Canadian Free Cash Portfolio via this link, which also provides updates to many of the other portfolios I track for the Globe.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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