Looking for bargain stocks with cash flow? Consider this strategy
Gardeners are trying ahead to the beginning of spring as they plan for planting season.
Similarly, traders ought to have a plan on the subject of the markets, and it would embrace planting a number of stocks from the Free Cash portfolio, which seems to be for bargains with a number of free cash circulation.
The portfolio has been an enormous grower with common annual good points of 16.9 per cent over the 26 years by way of to the top of February, 2026. In comparability, the Canadian inventory market, as represented by the S&P/TSX Composite Index, climbed at a median annual charge of 8.1 per cent over the identical interval.
(The returns listed below are primarily based on backtests utilizing month-to-month information from Bloomberg. They embrace dividend reinvestment however not fund charges, taxes, commissions or different buying and selling prices. The portfolios are equally weighted and rebalanced month-to-month, except in any other case famous.)
The Free Cash portfolio begins its search for bargain stocks with the biggest 300 on the Toronto Stock Exchange by market capitalization. It proceeds to purchase an equal greenback quantity of the ten with the bottom optimistic enterprise worth to free cash circulation ratios (EV/FCF).
Simply put, enterprise worth is the same as a agency’s market capitalization plus its web debt. Free cash circulation is theoretically the amount of cash an organization can distribute to its shareholders whereas sustaining its operations. In this case, it’s approximated by subtracting capital expenditures from cash circulation generated by operations (over the trailing 12 months.)
The authentic Free Cash portfolio comprises 10 stocks however the EV/FCF ratios of its holdings differ over time. For occasion, the portfolio at the moment owns stocks with ratios of as much as 7.0, however the cutoff modifications and in my prior replace it ended out at 8.6.
Instead of demanding a set variety of stocks, traders can flip the method round and make use of a fixed-ratio check that enables the variety of stocks within the portfolio to differ over time.
Four fixed-ratio portfolios show the success of the choice method. Like the Free Cash portfolio, they start with the biggest 300 stocks on the TSX however make investments an equal-dollar quantity in stocks with EV/FCF ratios of lower than 5, 10, 15, or 20 every month.
The fixed-ratio method beat the market with common annual good points of 16.9, 15.7, 17.2, and 16.6 per cent for the portfolios with ratios under 5, 10, 15, or 20, respectively, over the 26 years to the top of February, 2026.
The accompanying graph reveals how the variety of low-EV/FCF stocks within the portfolios various over the 26-year interval.
On common, the variety of stocks within the fixed-ratio portfolios was 6.6, 27.8, 52.7, and 78.4 for these with ratios under 5, 10, 15, and 20, respectively.
Importantly, there was one month through which there have been no stocks with EV/FCF ratios under 5 and more often than not there have been fewer than 10. On the opposite hand, there have been all the time at the very least 11 stocks with ratios under 10 available and a minimal of 23 with ratios under 15.
The variety of low-EV/FCF stocks within the fixed-ratio portfolios on the finish of February, 2026, was decrease than the averages of the final 26 years aside from the one with ratios of lower than 20, which was fairly near its common. Mind you, that was earlier than the market fell after the US attacked Iran.
(Fortunes are sometimes misplaced in warfare they usually’re simply the type of factor traders ought to fear about. A chronic battle may simply see inflation return with a vengeance and it would show to be fairly painful for the inventory market and the Free Cash portfolio.)
It’ll be attention-grabbing to see how the Free Cash portfolio fares over the long run. But, with maybe greater than slightly luck, it will proceed to develop over the following few market cycles.
Details on the stocks within the Free Cash portfolio and the others often adopted on the Globe and Mail can be found via this link.
Norman Rothery, PhD, CFA, is the founding father of StingyInvestor.com.
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