What are we looking for?
U.S. health-care companies that generate free cash flow and create shareholder wealth at an above-average rate.
The screen
We searched all U.S. health-care stocks with a market cap above $500-million (U.S.), filtering for the following metrics:
– free cash flow to invested capital of at least 15 per cent. Free cash flow is what remains to be reinvested in the company after all expenses are considered; high levels of cash better enable a company to fund research, develop new products, make acquisitions, buy back shares, reduce debt and pay dividends. (Invested capital represents the total cash investment that shareholders and debt holders have made in a company.)
– return on capital above 10 per cent;
– An economic performance index (EPI) at 1.5 or above. An EPI ratio (return on capital divided by cost of capital) above 1.0 indicates a company is able to create wealth for its shareholders (a higher EPI displays a greater rate of wealth creation);
– We are also displaying data for total sales, the five-year annualized growth rate of sales, as well as each company's price-to-earnings ratio (P/E).
More about StockPointer
StockPointer is a fundamental analysis tool based on an EVA (economic value added) model to quickly and easily identify investment opportunities. In addition to providing detailed reports on more than 6,500 companies (Canadian and U.S. stocks and American depositary receipts), StockPointer also allows investors to create personalized filters and build custom portfolios.
What did we find?
As the largest company in this group, Gilead Sciences Inc. also ranks near the top in near every metric displayed. Gilead combines the second-highest FCF/capital, return on capital and EPI, with the second lowest P/E ratio, and a top-tier five-year sales growth.
Centene Corp. and Medivation Inc. also presented elite FCF/capital rates in 2014. Medivation generated the highest return on capital of the group and has seen huge sales growth over the past five years. We'll note that Centene has much larger revenue for a similar market cap (Medivation is a young biopharmaceuticals company; Centene is an established health care service provider).
Over all, searching in the health-care sector for strong FCF generation identifies many high-growth companies, though this is also reflected in the elevated P/Es for the group. By also filtering for healthy EPI ratios, we ensure that these companies are maintaining a higher return on invested capital than that capital is costing.
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Nick Winch is an account manager for StockPointer at Inovestor Inc.