Small-cap strategy looks for quality amid volatility


What are we looking for?

Small capitalization stocks with tailwinds and a track record of long-term profitability.

In times of high volatility, small cap stocks tend to decline proportionately more than larger caps, as these less familiar names are considered more vulnerable to an economic downturn. While this is true on average, we think some quality companies could be unfairly punished because of this reputation.

The screen (add this screener here)

We screened Canadian stocks focusing on the following criteria:

  • Market capitalization between $500-million and $1.5-billion;
  • a StockPointer (SP) score higher than 60 – the score mainly considers risk-adjusted return on capital, earnings per share growth and free cash flow per share. The score varies between zero and 100. A score of 60 implies a better than average company;
  • five-year average return on capital higher than 7 per cent;
  • a positive one-year change in the economic performance index. The EPI represents the return on capital divided by the cost of capital. A positive change implies an improvement in the company’s risk-return profile. This is our metric to evaluate the company’s short-term performance.

For informational purposes, we have also included the actual EPI, price-to-earnings ratio, one-year price return and dividend yield. Please note that some ratios may be shown as of end of previous quarter.

More about Inovestor

Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock-picking by using model portfolios and easily communicate investment decisions with clients through client-friendly reports.

What we found

TSX-listed small-cap stocks

AW-UN-T A&W REVENUE ROYALTIES INCOME FUND 33.32 536 63 0.4 23.4 2.4 15.5 -14.1 5.4
HDI-T HARDWOODS DISTRIBUTION INC. 22.9 538 65 2.3 14.0 4.1 2.5 -42.4 2.1
AD-UN-T ALARIS EQUITY PARTNERS INCOME TRUST TRUST UNITS REG S 3C7 15.45 700 63 0.4 9.4 1.5 4.8 -17.2 8.8
AFM-X ALPHAMIN RESOURCES CORP. 0.62 789 67 1.2 10.7 3.2 5.3 -34.0 9.7
ABST-T ABSOLUTE SOFTWARE CORPORATION 15.92 814 66 1.3 15.5 2.6 n/a 12.7 2.9
CGO-T COGECO INC. 53.6 843 61 0.3 8.9 2.2 5.9 -36.6 4.6
ET-T EVERTZ TECHNOLOGIES LIMITED 11.08 845 70 1.4 15.9 2.8 9.6 -21.0 6.2
CVG-T CLAIRVEST GROUP INC. 69.05 1069 65 3.7 17.0 4.6 3.5 20.1 0.1
LNF-T LEON’S FURNITURE LIMITED 17.02 1141 64 0.8 11.8 2.9 6.5 -32.6 3.8
WDO-T WESDOME GOLD MINES LTD. 8.01 1141 69 0.5 14.1 2.3 39.5 -27.6 n/a
MTY-T MTY FOOD GROUP INC. 54.66 1334 63 0.3 10.6 0.9 14.5 -13.0 1.5


A&W Revenue Royalties Income Fund, which indirectly owns the trademarks used in A&W restaurants, has the highest five-year average return on capital of our list at 23.4 per cent. The trust receives a 3-per-cent royalty on the sales of restaurants in the royalty pool and distributes all royalties received after deducting the trust’s operating costs. The trust offers an attractive proposition as it should profit from the inflationary environment as royalties rise with higher sales, while not being affected by the operating expenses, such as higher food and wage costs.

Hardwoods Distribution Inc. , a wholesale distributor of building products in North America, has the second-highest EPI of our list at 4.1, but nevertheless has declined by 42.4 per cent over the past year as the market anticipates the effect of a slowing real estate market on the company’s results. While a slowdown seems already priced into the stock valuation, the company continues to perform well at the fundamental level as seen by the massive positive EPI change of 2.3, the second-highest of our screen.

Absolute Software Corp., a cybersecurity company, saw its share price increase by 12.7 per cent in the past year despite the collapse of the Canadian technology sector, which has declined 46.3 per cent over the same period. Part of the company’s positive aura could be attributed to its 2021 acquisition, for US$340-million, of NetMotion Software Inc., which will naturally boost the current year’s sales.

Investors are advised to do further research before investing in any of the companies listed in the accompanying table.

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