What are we looking for?
Income from Canadian free cash flow generators.
The screen
As the market progresses in a continuing "lower-for-longer" state – lower growth rates, lower commodity prices, lower interest rates, lower return expectations – some investors may be looking more to dividends as a tax-advantaged income alternative to low-interest bonds.
Simply chasing high-dividend yields alone, however, could be detrimental if those payouts are not sustainable. Firms that are able to generate and increase free cash flow – that is, operating cash flow left over after capital expenditures – may be better positioned to maintain their distributions.
To search for some potential investments offering sustainable dividend income, my colleague Lawrence Ullman and I used Bloomberg to rank Canadian firms from the S&P/TSX Composite with the best mix of:
- Forward earnings yield;
- Forward free cash flow yield;
- Forward return on equity greater than 5 per cent;
- Three-month consensus earnings estimate revision no worse than -10 per cent
We screened for firms with a dividend yield greater than 2 per cent, payout ratio (dividends as a percentage of earnings) less than 80 per cent and forward 12-month free cash flow expected to be positive and greater than trailing free cash flow.
More about the Ullman Group
The Ullman Group is an independent provider of strategic private capital management services to high-net-worth individuals, corporations, endowments, charities and foundations.
What we found
We used Bloomberg to perform a back-test starting June 30, 2006, reselecting an equally weighted portfolio of the top 10 qualifying stocks every quarter.
Over the full period, this strategy would have generated an annualized total return of 7.6 per cent compared with 4.4 per cent for the S&P/TSX composite total return index.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.
Lawrence Ullman, MBA, is a director, wealth management and Portfolio manager and Craig McGee, CFA, is a portfolio manager with the Ullman Group at Richardson GMP in Toronto.
Richardson GMP Ltd is a member of Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities L.P. Both used under licence by Richardson GMP Ltd.