In this week’s filter created for The Globe and Mail, we screened for Thirteen defensive U.S. health care and consumer staples stocks.
Looking back at May, it was the worst month so far in 2019 for the markets. The U.S.-China trade war spiralled deeper early in the month, with U.S. President Donald Trump raising tariffs on US$200-billion worth of Chinese products and China retaliating by setting tariffs on US$60-billion of American goods. Last week, the markets tumbled as the geopolitical mess worsened due to escalating trade tensions. In addition, last Thursday Mr. Trump threatened Mexico with a new wave of tariffs, which will begin on June 10. During this period of extended uncertainty, non-cyclical sectors hold up better due to their defensive characteristics. Today, we will screen U.S. health care and consumer staples stocks to identify some companies with solid operations and revenues that may be able to withstand this trade-war storm. We screened the U.S. stock universe by focusing on the following criteria:
- Market capitalization greater than US$10-billion;
- A positive 12-month change in the economic value-added (EVA) metric – a positive figure shows us that the company’s profits are increasing at a faster and greater pace than the costs of capital. The EVA is the economic profit generated by the company and is calculated as the net operating profit after tax minus capital expenses;
- A positive 12-month change in the economic performance index (EPI) and a current EPI greater than one – this ratio is the return on capital to cost of capital;
- A future-growth-value-to-market-value ratio (FGV/MV) of between 40 per cent and negative 70 per cent. We chose this range to eliminate stocks that trade at an exaggerated premium or discount as that would increase the risk. This ratio represents the proportion of the market value of the company that is made up of future growth expectations rather than the actual profit generated. The higher the percentage, the higher the baked-in premium for expected growth and the higher the risk.
- Free-cash-flow-to-capital ratio. This metric gives us an idea of how efficiently the company converts its invested capital to free cash flow, which is the amount left after all capital expenditures have been accounted for. It is an important measure because it gives us the company’s financial capacity to pay dividends, reduce debt and pursue growth opportunities. We are always looking for a positive ratio and more than 5 per cent is excellent.