What are we looking for?
S&P 500 companies with high economic performance, positive growth and trading below their historical valuation multiples.
The screen
We are using the following criteria:
- An economic performance index, or EPI (return on capital divided by cost of capital) above 1.5. An EPI ratio of 1.0 or more indicates a company’s capacity to create wealth for its shareholders (a higher EPI displays a greater rate of wealth creation);
- A return on capital of 10 per cent or higher;
- A positive (or at least not negative) net operating profit after tax (NOPAT) growth over 12 and 24 months;
- A positive economic value-added (EVA) growth over 12 and 24 months;
- A price-to-adjusted intrinsic value of 1.0 or lower. (The adjusted intrinsic value is our 12-month target price adjusted to the stock’s historical premium or discount against the non-adjusted intrinsic value. For example, we calculate an intrinsic value of $80 for company X, but historically, this stock has traded, on average, $20 above its intrinsic value. The adjusted intrinsic value will thus be $100, which represents the intrinsic value plus average historical spread);
- Positive free cash-flow to capital. This ratio gives a sense of how well the company uses the invested capital to generate free cash flow, 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;
- All companies have to pay a dividend;
- An annualized dividend growth rate of 5 per cent or higher over one, two, three and four years.
More about StockPointer
StockPointer is a fundamental analysis tool based on an economic value-added, or EVA, model to quickly and easily identify investment opportunities. In addition to providing detailed reports on more than 8,500 companies (Canadian and U.S. stocks and American depositary receipts), StockPointer also allows investors to create personalized filters and build custom portfolios.
What did we find?
Only 17 companies, which represents only 3.4 per cent of the S&P 500, match our list of criteria.
Home Depot Inc. has the highest EPI of the group and one of the best, steadiest dividend growth rates of 23 per cent a year over the past four years. The constantly high free cash flow Home Depot generates has allowed the company to build a massive $4-billion (U.S.) cash and cash equivalents position, which could be used to continue to increase dividends, buy back shares, reimburse long term debt and pay for capital expenditures.
Robert Half International Inc., a company that offers staffing and risk consulting services, is probably the most interesting option from a value perspective. The stock trades at a price-to-adjusted intrinsic value of only 0.8 while generating very good free cash flow and an EPI of 2.6, and offers an historical dividend growth rate of about 10 per cent a year. The stock lost about 24 per cent of its value over the past 12 months and just bounced back in August, gaining a little more than 5 per cent.
Strengthening economies in the United States and Canada are definitely good news for Home Depot, which results depend on the residential construction and home improvement markets, but also for Robert Half which will benefit from a more dynamic professional labour market.
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Jean-Didier Lapointe is a financial analyst for StockPointer at Inovestor Inc.