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What are we looking for?
Canadian-listed stocks generating strong cash flows.
Many investors have heard the term "cash is king," often in reference to keeping a portfolio in cash when markets are volatile. In a different context, there is also some truth to this when looking at a public company's financial statements. In particular, free cash flow is a measure of the company's cash flow from operating activities net of capital expenditures. Companies generating lots of free cash flow have the flexibility and liquidity to be able to pay dividends, reinvest back into future growth, buy back shares, or reduce debt – all things that ultimately add value to shareholders.
To find companies that have strong free cash flow and are growing cash flows in general, I used Morningstar CPMS to rank stocks in our Canadian database (today this consists of 700 companies) on the following criteria:
- Free-cash-flow yield (cash flow from operating activities less capital expenditures divided by enterprise value);
- Annual and quarterly cash flow momentum (the trailing four quarters of cash flow compared with the same figure four quarters ago and one quarter ago, respectively);
- Five-year cash flow growth rate (on average, how much the company has grown cash flows each year in the past five years);
- Cash flow estimate revision (today’s consensus estimate on cash flow per share, compared with the same figure three months ago);
- Five-year earnings deviation (a safety metric that measures how volatile a company’s bottom line has been over the past five years – lower figures preferred here).
To qualify, companies must have a market capitalization greater than $900-million.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back-test this strategy from August, 2004, to October, 2017. During this process, a maximum of 15 stocks were purchased with a maximum of four per economic sector to ensure reasonable diversification. Once a quarter, stocks would be sold if their rank fell below the top 50 per cent of the universe. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 13.1 per cent while the S&P/TSX composite total return index advanced 8 per cent. Today, only 13 stocks meet our requirements for purchase and are listed in the accompanying table.
As always, it is recommended that investors conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
Canadian-listed stocks with strong free cash flow
|Rank||Company||Ticker||Morningstar Sector||Market Cap ($ Mil)||Free CF Yield (%)||Annual CF Momentum (%)||Qtrly CF Momentum (%)||5Yr CF Growth Rate (%)||3M CF Estim. Revision (%)||5Yr Deviation of Earnings||Div. Yield (%)|
|1||Labrador Iron Ore||LIF-T||Basic Materials||1,368.3||11.9||212.7||34.5||4.4||23.3||33.0||4.7|
|2||Lucara Diamond Corp.||LUC-T||Basic Materials||937.4||14.7||20.7||52.6||27.2||8.8||40.2||4.1|
|3||Transcontinental Inc.||TCL.A-T||Consumer Cyclical||2,181.6||10.0||28.2||3.4||4.0||3.9||2.7||2.8|
|4||Magna Intl. Inc.||MG-T||Consumer Cyclical||24,511.7||7.9||14.8||2.2||25.6||-0.3||3.9||2.1|
|5||BCE Inc.||BCE-T||Comm. Services||55,430.9||4.0||3.3||2.0||0.1||0.3||1.8||4.7|
|6||Toromont Industries Ltd.||TIH-T||Industrials||4,407.4||1.6||4.9||3.2||5.9||9.3||4.0||1.4|
|7||Richelieu Hardware Ltd.||RCH-T||Consumer Cyclical||2,047.6||2.5||11.5||2.2||11.4||-0.6||2.4||0.6|
|8||WSP Global Inc.||WSP-T||Industrials||5,979.2||4.1||18.6||4.5||18.0||6.6||7.1||2.6|
|9||Centamin plc||CEE-T||Basic Materials||2,592.2||15.6||12.0||2.3||15.1||3.2||25.0||9.1|
|10||New Flyer Industries||NFI-T||Consumer Cyclical||3,182.3||5.6||23.7||4.5||162.4||-3.9||27.2||2.6|
|11||ATS Automation Tooling||ATA-T||Industrials||1,396.0||6.3||17.2||7.5||1.2||0.0||10.1||0.0|
|12||Badger Daylighting Ltd.||BAD-T||Industrials||1,019.9||0.9||64.3||1.6||9.7||0.7||22.4||1.7|
|13||Shaw Communications||SJR.B-T||Comm. Services||14,230.7||1.2||2.2||0.2||2.6||3.6||11.9||4.1|
Source: Morningstar Canada