What are we looking for?
We usually screen for stocks that generate positive wealth (economic value-added) for shareholders. Today, we didn't. Instead, we searched for Canadian companies that do not create wealth for now, but that are getting close to this objective. This type of screen is a little more aggressive, but could allow investors to find interesting companies "before it's too late."
The screen
We screened our Canadian universe of stocks for:
- A market capitalization of $300-million or above;
- An economic performance index, or EPI (return on capital divided by cost of capital) of minimum 0.7 and maximum of 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). Today we focus only on companies that generate either a slightly negative economic profit or no economic profit;
- A positive (or at least not negative) EPI change over 12 and 24 months;
- A positive return on capital;
- A positive (or at least not negative) return on capital change over 12 and 24 months;
- A positive sales change over 12 months and 24 months;
- A positive free-cash-flow-to-capital ratio. This ratio gives a sense of how well the company uses its 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.
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?
Eight companies fit our set of criteria. Interestingly, most of the companies in the list operate in the resources and mining industries, something that rarely happens in our screens. Some companies such as Premier Gold Mines Ltd. and Largo Resources Ltd. didn't even have revenues two years ago, hence the "n/a" in the 24-month sales change column.
We can't be sure that all these companies will some day generate a higher return on capital than their cost of capital (that is, an EPI greater than one), but they are certainly on the right path given how fast their return on capital is increasing.
Trevali Mining Corp., a zinc-focused mining company, has the second-highest return on capital of the group at 11.9 per cent, and has more than doubled its revenue for two consecutive years. Considering the industry it operates in, it also generates a good free-cash-flow-to-invested-capital ratio at 3.4 per cent: The median free-cash-flow-to-invested-capital ratio in the Canadian materials sector is minus 8 per cent. The stock is up 25 per cent year to date.
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.