Allan Robinson

For those with a more speculative bent, today we will look at the ability of micro-capitalization companies to generate superior profits based on their return on capital.

Matt Kacur, president of FSA Financial Science & Art Ltd. of Toronto, has developed and licenses a software to undertake a quantitative and mathematical analysis to determine future profitability.

The Return on Capital Report is done in conjunction with Haywood Securities Inc. analysts, who provide the analytic assessments of companies in the screen to adjust discrepancies between the model's valuation and the current stock prices. This helps identify changes in trends and outlook to determine undervalued and overvalued companies.


Most investors look at a company's earnings to see how profitable a company is. But earnings per share can be distorted by items such as amortization and depreciation. Some investors would rather look at calculations such as return on capital, which measures how well a company generates cash flow relative to the capital it has invested in the business.

The ROC Report analyzes about 180 companies, ranking them according to their cash flow internal rate of return. Today, we're just looking at some of the micro-cap ideas of Haywood Securities.

The final analysis produces a quarter-by-quarter screen that sizes up a company's ability to generate a return on invested capital (total assets plus accumulated depreciation), which is adjusted for inflation before the short-term liabilities are deducted.

The return is based on the present value of the cash flow over the estimated life cycles of the assets. The cash flow calculation is made by putting debt and equity on an equal footing by adjusting the operating profit by a normalized tax rate.


The report generates two portfolios, one small capitalization and the other a large-cap. Each portfolio is a list of 20 to 30 companies. Since its inception in early 2003, the small-cap portfolio has generated an annualized return of 21.8 per cent, while the large-cap portfolio, which was started a year later, has an annual return of 9.4 per cent. Both have outperformed their comparative indexes on the S&P/TSX.


“We don't track micro caps as a group,” Mr. Kacur said. “The [list is comprised of] companies that screen very well, but are not well know,” he said.

Over the years some of the micro-cap companies have performed very well and emerged as small-capitalization companies tracked by the ROC Report, he said. The companies in the list are generating high rates of return very early in their development, he said.

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