What are we looking for?
Following a Number Cruncher we did two weeks ago for the U.S. market, today we present the same approach for Canada's most discounted stocks that produce positive economic profit. Our goal with this screen is to try to differentiate real opportunities from potential value traps.
The screen
We screened our Canadian universe of stocks with the following criteria:
- A market capitalization of $500-million or above;
- An economic performance index, or EPI (return on capital divided by cost of capital) greater than one. An EPI ratio of one or more indicates a company’s capacity to create wealth for its shareholders (a higher EPI displays a greater rate of wealth creation);
- A negative future-growth-value-to-market-value ratio (this metric represents, in percentage, the portion of the market value that exceeds the company’s current operating value. The higher the number, the higher the baked-in premium for expected growth, and the higher the risk. A negative number reflects a discount. For example, a future-growth-value ratio of minus 50 per cent means the market value would need to increase by 50 per cent to equal what the company is worth if its operating profit stays flat forever);
- A return on capital greater than 10 per cent;
- A 12-month change in return on capital that is not negative;
- The 12- and 24-month sales change is displayed to easily weed out companies that have seen their return on capital increase “artificially,” without topline growth;
- A positive free-cash-flow-to-capital ratio. This ratio gives a sense of how well the company uses the invested capital to generate free cash flows, which could be used to stimulate growth, pay and/or increase dividends, reduce debt, etc. A positive figure is good, 5 per cent and above is excellent.
The stock price and dividend yield are displayed for informational purposes.
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 7,500 companies (Canadian stocks, U.S. stocks and American depositary receipts), StockPointer also allows investors to create personalized filters and build custom portfolios.
What did we find?
There is one obvious difference between our results this week for the Canadian market and the results of two weeks ago for the U.S. market. Almost all the discounted companies in Canada have generated positive revenue growth on 12 and 24 months, while only a minority of the discounted U.S. companies did. This could mean there are currently more high-quality companies available at an attractive price in Canada than in the United States. Air Canada, the most discounted company in our list, is also the highest wealth creator with an EPI of 2.7. Even though the stock gained 82 per cent over the past 12 months, the steep discount reflected by the FGV-to-MV of minus 89 per cent tells us there could be more to come.
New Flyer Industries Inc. and Logistec Corp., the next best wealth creators in our list, have each generated double-digit sales growth both on 12 and 24 months. Their respective FGV discounts of minus 5 per cent and minus 4 per cent may not seem like much, but we must remember that if their revenue and profit continue to grow like they have, those discounts will become larger and larger if the stock price doesn't follow.
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Jean-Didier Lapointe is a financial analyst at Inovestor Inc.