Here’s an interesting study from Canadian researchers that could help you choose more profitable stocks to invest in. It’s a little bit common sense, but the statistics are interesting nevertheless, and you should consider their theory when pursuing investment opportunities.
Two analysts at the Canadian Imperial Bank of Commerce have studied various balance sheets in an effort to come up with a method of determining which stocks will do well in future.
While many in the field will agree that how a company can take care of its debt affects the market, these two analysts specifically took a look at how to best analyze a balance sheet in order to deduce future performance.
They found that not every ratio on a balance sheet reflected the same future; in fact, some were better indicators than others.
“Companies with high cash flow/debt ratios have a stronger ability to repay their debt, and the market rewards those companies with higher returns,” the analysts said in a recent research note.
They note that the best way to look into the future is by calculating a company’s debt to cash flow ratio. In this equation, you take the trailing cash flow and divide it by the long-term debt.
From the sheets that the analysts reviewed, they noticed a trend in those with higher cash flow to debt ratio had upwards of 11% higher returns that those companies that had lower ratios in the same field.
A company is shown to be able to pay back a debt and the interest associated with that when they score well on cash flow to debt ratio, as compared to the sector median and the interest coverage ratio.
When they used these ratios on a number of Canadian companies, they came up with a portfolio of appealing stocks. They had excellent cash flow to debt ratios and acceptable interest coverage ratios.
The stocks they identified included Canaccord Capital Inc., Husky Energy Inc., NuVusta Energy Ltd., and Shell Canada Ltd.
To potentially profit by an average of 11% more than you normally do, perhaps taking a more critical look at a company’s cash flow to debt ratio may be worth your while.