What are we looking for?
U.S. companies with an history of robust free-cash-flow-to-capital.
The total return of the S&P 500 over the past year has been 16.3 per cent, whereas the S&P 400 – an index of mid-capitalization stocks – has shown a more modest 3.5-per-cent gain. Fear of a looming recession has led the market to adopt a more risk-averse stance, which tends to favour large-cap stocks. Nevertheless, considering investments in mid-cap companies with robust cash generation could serve as a strategy to enhance expected returns while mitigating risks.
We screened U.S. companies with a market capitalization between US$5-billion and US$10-billion, looking for:
- one-year and five-year average ratio of free-cash-flow-to-capital greater than 4 per cent. We look for companies with solid current and historical free-cash-flow metrics.
- relative economic performance index (relative EPI) greater than 0.7. Relative EPI is a multistep calculation that compares the profitability of a company with its valuation and cost of capital. Higher profitability, a lower valuation and a lower cost of capital increase the ratio.
- five-year return on capital greater than 10 per cent
- positive one-year price return
Owing to the unique nature of the free-cash-flow metric of financial companies, we decided to exclude them from our screen.
For informational purposes, we have also included six-month price return, P/E ratio and dividend yield.
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What we found
Dropbox Inc. DBX-Q, which provides cloud storage services, demonstrates strong financials, boasting a five-year free-cash-flow-to capital of 22.3 per cent, surpassing its current one-year level of 19.2 per cent. The company’s relative EPI of 0.8 reflects its robust economic position at a reasonable price. The company has an attractive P/E of 17, which is particularly noteworthy given it operates in the information technology sector – one known for its relatively higher valuations.
UFP Industries Inc. UFPI-Q is a global manufacturing company specializing in wood and wood alternatives with a focus on innovation and sustainability. The company has demonstrated vigorous price momentum over the past one-year and six-month periods, delivering impressive price returns of 43 per cent and 31.8 per cent, respectively. This significant price performance could be attributed to above-average free-cash-flow-to-capital over the past year. It came in at 24.1 per cent, surpassing its five-year average of 16.6 per cent.
Murphy USA Inc. MUSA-N operates in the retail sector, focusing on fuel and convenience stores. It sustains solid financials with a five-year return on capital of 21.8 per cent, the highest on our list. The company’s relative EPI of 1.0 indicates a balanced economic performance and valuation. While the stock provides a modest dividend yield of just 0.4 per cent, historically, it has leaned toward returning funds to shareholders via buybacks.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
Anthony Ménard, CFA, is vice-president of data management at Inovestor.
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