When you are doing your homework the idea is to narrow down the list of investments and then choose among the best. In a recent column in the Globe and Mail, Jean-Didier LaPointe from StockPointer was looking from the S&P 500 companies for those companies with high economic performance, positive growth and trading below their historical multiples.

Started with the S&P 500 companies with the following criteria:

An economic performance index or EPI (return on capital divided by cost of capital) above 1.5. The rule of thumb is an EPI of 1.0 means the ability to create wealth; the higher the ratio the better it is for investors.

A return on capital (R/C) of 10% or higher

A positive net operating profit after tax (NOPAT) growth over 1 year and 2 years.

A positive economic value added growth over 1 year and 2 years

Positive free cash flow to capital. The ratio gives a sense of how well the company uses the invested capital to generate free cash flow. A positive number is good, above 5% excellent

A dividend growth rate of 5% or higher 1, 2,3, and 4 years

In using the above criteria 17 companies of the 500 meant the criteria.

Company                  EPI      R/C    NOPAT     EVA Growth     FCF/   Dividend   Anuual Div Growth

1 Yr  2Yr      1Yr     2Yr          Cap      Yield          1YR   2YR    4YR

%      %    %           %        %             %            %               %      %          %

Home Depot           2.8        24.9  60   110        63     110           16.3         2.1           20.8   22.0   23.0

Marriott Intl           2.7       24.8   60   120        85   155             18.3         1.7           23.5    21.6   25.0

Starbucks                2.6        22.2   40  110         30     88           12.4         1.4            24.6    23.9  24.1

Robert Half Intl     2.6        29.0   70  200        58  186            16.1         2.3             10.5    11.1     9.7

Sherwin Williams  2.5       21.6    80   110        71   102           17.2          1.2           23.8     19.9  18.9

Southwest Air         2.3       20.3   330  500       322 500          11.8          1.0           27.5     34.4  92.8

Hormel Foods         2.3        17.8    80   130        62    86            8.1         1.5             17.9     20.6   18.0

Lockheed Martin    2.2        15.3   100   150       61   135            7.3         2.7            10.6     12.0    14.5

UPS                             2.1        17.2   100     90      92    97            7.4         2.9            7.9       8.2      8.5

Apt Invest & Mgmt 1.9       12.8    30    150       34   204          4.1          2.8           14.6      12.3    20.4

Tractor Supply         1.9       18.4   30      80        12     45            4.0        1.2            23.5      23.6     31.6

Scripps Network Interactive; Public Storage; Lowe’s Companies; VF Corp and Target Corp were the other 6 on the list.

Linking to dividend paying stocks, every year it is easier to use whatever criteria you have to find the best companies. In this case they have high economic performance continuing with positive growth and because they are trading less their historical valuation multiples it is possible for the stocks to go higher. If you buy quality over time and continue to buy as the dividends are reinvested your wealth will increase. With the stock price go up and down, yes – however if you believe the company will continue to be a leader in its field then over the long term you will have fewer worries. The important aspect is narrow the field to quality stocks in this case the criteria started with 500 and ended with 17 or 3.4% of the total. After narrowing the field down you will have a choice for example in home renovations – is Home Depot better than Lowe’s given they are both good choices?  but it is choice of quality and that is a good place to be making decisions from.

There are more questions than answers, till the next time – to raising questions.