What are we looking for?
When market sentiment turns pessimistic, fundamentally strong companies can become undervalued. However, it can be difficult to tell the difference between a company that is temporarily undervalued and likely to recover, and one that has been permanently weakened by competition.
One useful signal is management’s willingness to repurchase shares aggressively relative to the company’s financial capacity. When a company has a strong balance sheet or meaningful cash reserves, management may choose to buy back stock at depressed valuations. This can suggest confidence that the shares are undervalued and that repurchases are an attractive use of capital.
The screen
We screened the U.S. equity universe for companies with market capitalization greater than US$5-billion and ranked companies in the top 25th percentile based on the following criteria:
- free cash flow yield (FCFY) greater than 5 per cent – identifying companies generating healthy cash flow relative to enterprise value;
- quarterly year-over-year sales growth greater than 10 per cent – indicating that underlying business momentum remains positive;
- enterprise value-to-earnings before interest, taxes, depreciation and amortization (EV/EBITDA) below 10 times – finding companies trading at cheap valuations;
- buyback yield-to-free cash flow yield (BBY/FCFY) greater than 80 per cent – suggesting management is aggressively repurchasing shares, potentially taking advantage of market pessimism;
- negative one-year price return – confirming that the stock has been pressured by negative market sentiment.
For informational purposes, we also included dividend yield, buyback yield and the quarterly year-over-year EBIT (earnings before interest and taxes) growth.
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What we found
Companies where management is betting on stock
The Trade Desk Inc. TTD-Q operates a technology platform that helps advertisers manage digital advertising campaigns across various channels. The company has been significantly pressured by the market, with a one-year price decline of 61.5 per cent. However, fundamentals remain strong, with sales growth of 16.2 per cent. The company has the third-highest BBY/FCFY in our screen at 148.3 per cent with an EV/EBITDA multiple of 9.3 times, suggesting management is aggressively repurchasing shares at depressed valuations, providing a strong opportunity for contrarian investors.
Universal Health Services Inc. UHS-N owns and operates acute-care hospitals, outpatient facilities and behavioural health centers across the United States. The company shows positive fundamentals with sales growth of 14.9 per cent, and one of the lowest EV/EBITDA ratios in the screen at 6.2 times. Despite a one-year price decline of 7.5 per cent, its buyback yield of 8.6 per cent is well above its free cash flow yield, indicating management may see the shares as undervalued, providing an attractive opportunity for value investors.
EPAM Systems Inc. EPAM-N is a digital transformation services company that provides software engineering, product development, cloud, data and consulting services. The stock has declined 44.8 per cent over the past year, suggesting the market has taken a pessimistic view of technology consulting demand. However, the company shows strong quality and value characteristics in our screen, with quarterly sales and EBIT increased 16.3 per cent and 15.7 per cent, respectively, versus the same quarter one year ago. It may appeal to investors who are seeking resilient businesses at attractive valuations.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
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Anuj Anand, MBA, LLM is an Investment Analyst at Inovestor.