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number cruncher

What are we looking for?

Undervalued companies with predictable sales and cash flow.

The screen

The risk-off trade has continued into February as a flight to safety has steered investors away from momentum and riskier equities. Because of heightened volatility in recent years, approaches focused on higher predictability and lower volatility have been fairly successful at offering a smoother return stream.

In order to identify some potentially undervalued firms with more predictable revenue and cash flow, my colleague Lawrence Ullman and I used Bloomberg to rank firms in the S&P/TSX composite index or the S&P 500 index with the best mix of:

  • sales variability (measured as the standard deviation of sales per share over the past five years divided by the median value of sales per share);
  • free-cash-flow variability;
  • five-year beta;
  • free-cash-flow yield (forward 12-month FCF as a percentage of latest price);
  • return on equity.

Qualifying stocks must have a flat or positive three-month consensus earnings estimate revision and five-year beta less than one, suggesting the stock has been less volatile than the market.

More about the Ullman Group

The Ullman Group is an independent provider of strategic private capital management services to high-net-worth individuals, corporations, endowments, charities and foundations.

What we found

We used Bloomberg to perform a back-test starting Jan. 31, 2006, selecting an equally weighted portfolio of the best 20 companies. The portfolio would be reselected and rebalanced quarterly.

Over the 10-year period, this strategy would have generated an annualized total return, in Canadian dollars, of 12.8 per cent compared with 8.7 per cent for the S&P 500 (also in Canadian currency). The S&P 500 low volatility index, which is designed to measure the performance of the 100 least-volatile stocks of the S&P 500 index, has posted a total return – again in Canadian dollars – of 11.4 per cent over the same period.

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.

Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.

Richardson GMP Ltd. is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities LP. Both used under licence by Richardson GMP Ltd.

Undervalued firms with predictable revenue and cash flow