Screening for Cheap Yield
My basic approach to investing is to look for companies that a.) generate large amounts of free cash flow, b.) trade cheaply relative to that cash flow, and c.) have some mechanism for returning capital to shareholders, whether through buybacks, dividends or both.
I thought it would be interesting to develop a screen for companies that meet all three of these criteria. A stock screen is an excellent way to generate "an inbox of ideas," to borrow from a phrase from Val Hughes of the excellent Value Guys podcast. In other words, the screen is not meant to produce a list of companies to buy, but is instead a starting point for doing the due diligence always required before initiating a position.
I created a very simple screen using the excellent Portfolio123 that would generate a list of companies meeting the below criterion:
(Dividend Yield + Buyback Yield) > (EV/FCF)
In other words, the screen will return companies whose net payout yield, expressed in percentage terms, exceeds their current valuation ratio. Buyback Yield is defined as the net reduction in total shares outstanding over the preceding twelve months divided by the total shares outstanding as of twelve months ago; Enterprise Value is market cap + total debt - cash; and free cash flow is cash flow from operations minus capital expenditures. I also added a criterion that the company must have been FCF positive for each of the past three years.
Below are a few of the names that popped up on the screen, along with some of my thoughts.
QLogic Corp (QLGC):
QLogic pays no dividend, repurchased 7.5% of its outstanding shares over the trailing twelve months, and has an EV/FCF ratio of 4.7. The company manufactures equipment that facilitates the transfer of data between servers, networks and storage (you can read here for more background). Sales have essentially been flat for the last ten years, though part of that stagnation can be attributed to the company's 2012 sale of its InfiniBand assets to Intel for $125 million in cash. A pristine balance sheet should put a floor on the stock price while investors wait for a catalyst to materialize.
Capella pays no dividend, repurchased 10.7% of its outstanding shares over the trailing twelve months, and has an EV/FCF ratio of 6.3. Capella likely needs no introduction, as the for-profit education sector has come under increased scrutiny in recent years. While the headwinds are well documented, it's worth noting that Capella's 3-year cohort default rate is just 9.7%; this compares favorably to the national average of 13.4% (source) and stands in stark contrast to the astronomical default rates of its for-profit competitors. Given this data point, it’s possible the Capella could stand to benefit from more stringent federal requirements as competitors fall by the wayside.
WellPoint Inc (WLP):
WellPoint carries a 2.2% dividend yield, repurchased 10% of its outstanding shares over the trailing twelve months, and has an EV/FCF ratio of 8.3. WellPoint is a managed care provider and the largest licensee of Blue Cross & Blue Shield; according to the company's IR site, one in nine Americans receive their coverage through WellPoint's affiliated plans. While the intricacies of the Affordable Care Act and its ultimate effects on the industry remain nebulous, it’s my belief that, in general, regulations of this sort benefit the largest and most firmly entrenched players in the industry; WLP certainly fits into that category. The current dividend payout represents a mere 17% of free cash flow, which could make this an attractive opportunity for the dividend growth investor.
This screen produced a number of familiar names for me, but also a few new ones. Maybe I'll follow up with some additional names or screen ideas in a future post. Thanks for reading!