What are we looking for?
Small cap stocks have generally been hit harder than large caps in the current market turmoil. The S&P/TSX SmallCap Index is down 30.6 per cent year-to-date, while the S&P/TSX Composite has lost 15.8 per cent over the same period.
Companies with lower capitalizations are more likely than the large caps to have liquidity issues in dealing with the COVID-19 fallout. However, it is incorrect to conclude every small cap is in danger. Today, we look for Canadian small caps with a focus on companies that have a strong balance sheet, a healthy return on capital and an attractive track record. Please note all financial ratios are reported at the end of the previous quarter and do not reflect the impact of COVID-19.
We screened Canadian companies focusing on the following criteria:
- Market capitalization between $250-million and $500-million;
- Economic performance index (EPI) higher than one – the EPI is the return on capital divided by the cost of capital. The return on capital is a measure of profitability and the cost of capital a measure of risk. We want a company that generates a decent amount of money while we take into account operational risk;
- Positive sales growth over 24 months – a great company should have been able to increase its revenue in the past two years;
- Long-term debt lower than $100-million – we want a company with a low level of debt;
- A StockPointer (SP) score higher than 50 – the SP score is a complex composite that focus on quality and value. This is our track record criterion. The score varies between zero and 100; a score above 50 is considered good;
- Positive free-cash-flow-to-capital – we want a company that generates enough liquidity to make it through the crisis.
For informational purposes, we have also included recent stock price, dividend yield and one-year price return.
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||MKT CAP ($MIL.)
||ECON PERF INDEX
||Long-term debt ($MIL.)
||SALES CH. 24M (%)
||FCF / CAPITAL (%)
||DIV. YIELD (%)
||1Y PRICE RTN. (%)
||Viemed Healthcare Inc
||Senvest Capital Inc.
||Information Services Corp.
||Magellan Aerospace Corporation
||Absolute Software Corporation
What we found
Home medical equipment supplier Viemed Healthcare Inc. has good overall scores and systematically generated return on capital above its cost of capital. The company, which provides post-acute respiratory care services, said recently it is working with health agencies in helping to transition patients with chronic respiratory failure out of hospital quicker in order to free up beds for COVID-19 patients.
Senvest Capital Inc. has interest in investment management and direct investing in public securities and private investments. Revenue is directly affected by the change in market value of its investments. Senvest has generally good scores but in the short term it will take heavy losses we expect it to take heavy losses because of the market downturn. The SP score considers the company of moderate quality because of the volatility of the business model.
Information Services Corp., which provides registry and information management services for public data and records, has a decent EPI and is an alternative for investors looking for higher yielding stocks. In the past five years the company has produced a great free-cash-flow-to-capital, allowing for a dividend yield of 5.5 per cent.
Tecsys Inc. provides supply chain services for warehouse, distribution and transportation management. Its large exposure to the hospital sector could provide it with strong tail winds.
Components and systems manufacturer Magellan Aerospace Corp. has a strong track record, but its exposure to the aerospace industry leads us to temper our view on its outlook because of COVID-19.
Finally, data risk manager Absolute Software Inc. is well positioned to grow its sales in the next quarter as more employees work remotely.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
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For readers with an Inovestor for Advisors account, Here is the screener we used