What are we looking for?
Cash machines. We’re hunting for companies that can spew gushers of loonies even after covering all expenses. By virtue of their ability to generate cash, these companies are in great position to take advantage of investment opportunities, which should bode well for their shareholders.
More about today’s screen
Craig McGee, senior consultant at CPMS Morningstar Canada, created today’s offering. He filtered the CPMS database of Canadian companies for large firms with high levels of free cash flow in comparison to their stock prices, revenues and debt. (For purposes of this screen, we defined free cash flow as operating cash flow after subtracting capital expenditures.)
Mr. McGee looked for firms with:
– a market cap greater than $1-billion;
– free cash flow yield (free cash flow divided by share price) of greater than 10 per cent over the past year;
– free cash flow margin (free cash flow divided by revenue) of greater than 10 per cent over the past year;
– a ratio of free cash flow to long-term debt that is great than 0.5;
– interest coverage ratio (cash flow divided by interest expense) greater than 5.
The top 10 companies are shown in the accompanying table. They’re listed by total return over the year to date.
More about CPMS
CPMS, a division of Morningstar Canada, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers through software and Web-based tools. It covers more than 700 Canadian and 2,200 U.S. stocks, and adjusts for unusual accounting items in each company’s quarterly results to make sure screens can perform correctly.
What did we find?
Seven of our top 10 cash machines have delivered double-digit gains so far this year. That’s no accident: companies with lots of free cash flow are usually catnip for investors.
Nothing is guaranteed, however. Among other things, you should make sure that a company rich in free cash flow is not just enjoying a temporary boom. Look back at financial results over several years, and consider an industry’s prospects over the next few years, before loading up on any of the companies on our list.