What are we looking for?
The Volatility Index (VIX), a measure of market fear and uncertainty, spiked above 40 last week and sent investors flocking out of equity markets. Typically, a value above 30 is associated with a large amount of market volatility. I'm looking for U.S. and Canadian companies with a market cap greater than $10-billion that can withstand volatile markets.
The Screen
When looking to combat volatility, it is more important for investors to buy companies that help protect the downside than to capture all of the upside movements of the market. The companies required a three-year beta of less than one and a daily volatility of less than 1.5 per cent. A beta of one typically means that the stock will roughly follow the market.
To gauge the relative leverage of these firms, I looked for a value of total debt to EBITDA (earnings before interest, taxes, depreciation and amortization) of less than three. A low ratio indicates that these firms have better ability to pay off their debt and gives investors an idea of the time in which they could theoretically pay off that debt. In measuring the amount of growth and income the firms provide, the screen required a dividend yield of more than 1 per cent and a five-year average growth rate of free operating cash flow greater than 4 per cent. An examination of free cash flow growth is important because this is the cash that a company can generate to spend on new projects, expand current operations or distribute to shareholders.
I used Eikon's proprietary StarMine Credit Risk Model, which evaluates the credit risk and likelihood of default of companies, and screened for firms ranked in the top 80th percentile.
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What did we find?
I used Thomson Reuters Eikon and found 15 companies that fit the screening criteria. Fastenal Co. sells industrial machinery and construction supplies, including fasteners such as nuts and bolts. In addition to having a low beta, Fastenal has very low debt and profitability margins that are much higher than its industry peers. Bell Canada Enterprises Inc. (BCE) pays a dividend of nearly 5 per cent and has a beta that is significantly less than one. BCE's solid balance sheet is strengthened by its steady and predictable recurring revenue streams.
Charles Martin, CFA, works in the financial and risk unit of Thomson Reuters and specializes in asset management.