Gardeners are looking forward to the start of spring as they plan for planting season.
Similarly, investors should have a plan when it comes to the markets, and it might include planting a few stocks from the Free Cash portfolio, which looks for bargains with lots of free cash flow.
The portfolio has been a big grower with average annual gains of 16.9 per cent over the 26 years through to the end of February, 2026. In comparison, the Canadian stock market, as represented by the S&P/TSX Composite Index, climbed at an average annual rate of 8.1 per cent over the same period.
(The returns herein are based on backtests using monthly data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are equally weighted and rebalanced monthly, unless otherwise noted.)
The Free Cash portfolio starts its search for bargain stocks with the largest 300 on the Toronto Stock Exchange by market capitalization. It proceeds to buy an equal dollar amount of the 10 with the lowest positive enterprise value to free cash flow ratios (EV/FCF).
Simply put, enterprise value is equal to a firm’s market capitalization plus its net debt. Free cash flow is theoretically the amount of money a company can distribute to its shareholders while maintaining its operations. In this case, it is approximated by subtracting capital expenditures from cash flow generated by operations (over the trailing 12 months.)
The original Free Cash portfolio contains 10 stocks but the EV/FCF ratios of its holdings vary over time. For instance, the portfolio currently owns stocks with ratios of up to 7.0, but the cutoff changes and in my prior update it topped out at 8.6.
Instead of demanding a set number of stocks, investors can flip the approach around and employ a fixed-ratio test that allows the number of stocks in the portfolio to vary over time.
Four fixed-ratio portfolios demonstrate the success of the alternative approach. Like the Free Cash portfolio, they begin with the largest 300 stocks on the TSX but invest an equal-dollar amount in stocks with EV/FCF ratios of less than 5, 10, 15, or 20 each month.
The fixed-ratio approach beat the market with average annual gains of 16.9, 15.7, 17.2, and 16.6 per cent for the portfolios with ratios below 5, 10, 15, or 20, respectively, over the 26 years to the end of February, 2026.
The accompanying graph shows how the number of low-EV/FCF stocks in the portfolios varied over the 26-year period.
On average, the number of stocks in the fixed-ratio portfolios was 6.6, 27.8, 52.7, and 78.4 for those with ratios below 5, 10, 15, and 20, respectively.
Importantly, there was one month in which there were no stocks with EV/FCF ratios below 5 and most of the time there were fewer than 10. On the other hand, there were always at least 11 stocks with ratios below 10 to be had and a minimum of 23 with ratios below 15.
The number of low-EV/FCF stocks in the fixed-ratio portfolios at the end of February, 2026, was lower than the averages of the last 26 years apart from the one with ratios of less than 20, which was quite close to its average. Mind you, that was before the market fell after the U.S. attacked Iran.
(Fortunes are often lost in war and they’re just the sort of thing investors should worry about. A prolonged conflict could easily see inflation return with a vengeance and it might prove to be quite painful for the stock market and the Free Cash portfolio.)
It’ll be interesting to see how the Free Cash portfolio fares over the long term. But, with perhaps more than a little luck, it’ll continue to grow over the next few market cycles.
Details on the stocks in the Free Cash portfolio and the others regularly followed at the Globe and Mail can be found via this link.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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