In order to temper inflationary pressure, the Bank of Canada has raised interest rates significantly in the last two years. The most recent one was an increase of 25 basis points to 4.75% in June 2023. As a result, fixed-income assets like bonds become an attractive asset class once again after being ignored by investors for many years due to their low yield.

As investors, we constantly compare available investment alternatives to get the best returns with the lowest risk out of every dollar invested. With interest rates at approximately 5%, conservative investors might only find equity investments attractive if they can get at least a 5% free cash flow yield with a high degree of confidence, in addition to some potential for added returns through organic growth (price increases and volume gains without significant capital investments) and business improvement.

The equivalent yield that a business offers is often referred to as free cash flow yield. Free cash flow yield is basically the net cash that could be taken out of a business each year after taking into account all expenses and capital expenditures to maintain the business without affecting its underlying fundamentals. This free cash flow could be allocated by managers in the best interest of shareholders either to pursue growth through capital investments, acquisitions, or being paid out to shareholders through dividends or share repurchases. 

Below we have screened for companies with the following criteria:

• Positive revenue compounded annual growth rate (CAGR) in the last seven years
• Market cap larger than $100 million
• Free Cash Flow Yield of at least 5%
• Return on Capital of at least 12%

The criteria above measures a company’s free cash flow yield in the trailing twelve-months of at least 5%, which is approximately equivalent to the current level of interest rates. We feel that this is a good return for equity investors in this environment because they also enjoy the potential upside that equities offer on top of the free cash flow yield.

As usual, we prefer companies that are over $100 million in market cap, as these companies have proven themselves to be mature entities with a solid track record to assess. In addition, we add one more filter to screen out low-return businesses, as we believe companies that earn high returns on capital are high-quality businesses over the long term.

Lastly, we screen for companies with positive revenue growth over 7 years. This is not a really high bar to achieve, but after factoring in the previous two criteria of minimum yield (5%) and return on capital (12%), the screen only results in 20 names.

Here is the screener:

A quick reminder that investors need to be mindful regarding names in the Energy sector as most names in the Energy space have experienced an abnormal tailwind due to high oil prices in the last two years. As a result, these names may appear attractive due to being at their peak in the business cycle.

Members will recognize some of the names that we cover in our Model Portfolios and coverage lists such as TFI International Inc. (TFII), Spin Master Corp. (TOY) and BRP Inc. (DOO).

As usual, these companies on the list are not recommendations, but rather a starting point that helps investors generate potential investment ideas and strategies. Investors can view our previous screener blog here.

Take Care,

Disclosure: The analyst(s) responsible for this report do not have a financial or other interest in the securities mentioned.