The idea behind this was to see if I could come up with a screen that included the characteristics of a great company and backtested well. So what are these characteristics?
- High returns on capital.
- High margins.
- Consistently generate free cash flow.
- Not too much debt.
- Stable revenues with either growth or at worse small declines (yes even the best companies do experience periods of small declines in sales).
As these characteristics are much desired, companies are usually richly priced. So I filtered out all the stocks trading at a premium to the market (S&P 500). When I ran this screen on the U.S. this morning, I came up with the below 34 companies. This is my “Best Companies” screen which I have posted about in the past and backtested well.
| Ticker | Name | Ticker | Name | ||
| 1 | MMM | 3M CO | 18 | ITW | ILLINOIS TOOL WO |
| 2 | ABBV | ABBVIE INC | 19 | IPGP | IPG PHOTONICS |
| 3 | ALK | ALASKA AIR GROUP | 20 | KLAC | KLA-TENCOR CORP |
| 4 | MO | ALTRIA GROUP INC | 21 | MCD | MCDONALDS CORP |
| 5 | AME | AMETEK INC | 22 | KORS | MICHAEL KORS HOL |
| 6 | AAPL | APPLE INC | 23 | MCO | MOODY’S CORP |
| 7 | AMAT | APPLIED MATERIAL | 24 | PAYX | PAYCHEX INC |
| 8 | BIIB | BIOGEN INC | 25 | PM | PHILIP MORRIS IN |
| 9 | BKNG | BOOKING HOLDINGS | 26 | REGN | REGENERON PHARM |
| 10 | CELG | CELGENE CORP | 27 | COL | ROCKWELL COLLINS |
| 11 | CERN | CERNER CORP | 28 | SWKS | SKYWORKS SOLUTIO |
| 12 | CL | COLGATE-PALMOLIV | 29 | SNA | SNAP-ON INC |
| 13 | DFS | DISCOVER FINANCI | 30 | SYF | SYNCHRONY FINANC |
| 14 | EFX | EQUIFAX INC | 31 | TROW | T ROWE PRICE GRP |
| 15 | FFIV | F5 NETWORKS | 32 | TXN | TEXAS INSTRUMENT |
| 16 | FAST | FASTENAL CO | 33 | VIAB | VIACOM INC-B |
| 17 | HRB | H&R BLOCK INC | 34 | DIS | WALT DISNEY CO |
That took care about quality and valuation. Now, how about growth? For that, I screened for companies that also have the below additional characteristics:
- Last quarter EBITDA margin was higher than the margin a year ago.
- Expected EBITDA margin for the fiscal year is expected to be higher than last year.
- EBITDA for the fiscal year is expected to be higher than last year.
- Sales for the fiscal year is expected to be higher than last year.
This leaves 17 companies (1/2 of the list):
| Ticker | Name | |
| 1 | AME | AMETEK INC |
| 2 | AAPL | APPLE INC |
| 3 | BIIB | BIOGEN INC |
| 4 | CCMP | CABOT MICROELEC |
| 5 | CELG | CELGENE CORP |
| 6 | CHH | CHOICE HOTELS |
| 7 | EV | EATON VANCE CORP |
| 8 | FAST | FASTENAL CO |
| 9 | IEX | IDEX CORP |
| 10 | KLAC | KLA-TENCOR CORP |
| 11 | MCO | MOODY’S CORP |
| 12 | COL | ROCKWELL COLLINS |
| 13 | SEIC | SEI INVESTMENTS |
| 14 | SIRI | SIRIUS XM HOLDIN |
| 15 | SWKS | SKYWORKS SOLUTIO |
| 16 | TROW | T ROWE PRICE GRP |
| 17 | TXN | TEXAS INSTRUMENT |
Obviously, I used Street expectations and while these can be widely off, using this additional filters resulted in less volatility in a backtest I ran. Of course, this approach too has its flaws such as missing the upside on unexpected improvement in margins (reversion to the mean) or turnaround situations among these historically strong firms. And while these filters reduced volatility in “Best Companies”, it doesn’t necessarily help screens with a deeper value focus.
Happy hunting!
