With interest rates expected to rise and inflation increases likely, portfolio manager Ted Theodore outlines his strategy for choosing companies that will stay strong during a possible economic slowdown
The prospect of further interest rate hikes means companies with free cash flow and good balance sheets are an attractive option for investors.
That’s the strategy held by Ted Theodore, portfolio manager of the TrimTabs US and International Free-Cash-Flow ETFs, who wants to align with companies who do not have to buy back securities with debt.
According to Theodore, it’s a three-point checklist for picking out firms he believes give his portfolios “a little edge” with central banks poised to tighten their belts.
He said: “The way we do it in our portfolio is we are focused on three quantitative factors. They start with free cash flow; we are really focused on trying to find companies that have good long-term prospects and are sustainable because it’s so difficult now to just take corporate gap reports at face value with so much discretion determining them.”
Theodore believes free cash flow is a more reliable indicator than simply going on what management tells his firm. He says that the second factor, strong balance sheets, completes the package when looking for a higher quality company.
He said: “The last factor, since we are owners in these shares, is that we want fewer other owners, so we like it when the share count goes down.”
He added that having companies able to buy back shares without using debt gives investors a cushion when rates and inflation increase.
“That’s important because there is expectation that rates are going to rise,” he said. “Certainly short rates, the Fed is going to do it, and maybe long rates. There are a few signs that inflation is going to increase, not dramatically yet, but even in Europe they’ve started moving out of the deflation. There are also a couple of indications in the US that inflation is gradually picking up.
“We have the Fed reserve actually reducing its balance sheets so there will be more supply of bonds, so you would expect interest rates to rise. That would be a challenge for companies to buy back its stock that are using debt.
“To that extent we have a little edge. If things don’t go well and the economy is not as strong as people think, that’s also a bit of a cushion that will moderate some of the initial pressures.”
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That’s the strategy held by Ted Theodore, portfolio manager of the TrimTabs US and International Free-Cash-Flow ETFs, who wants to align with companies who do not have to buy back securities with debt.
According to Theodore, it’s a three-point checklist for picking out firms he believes give his portfolios “a little edge” with central banks poised to tighten their belts.
He said: “The way we do it in our portfolio is we are focused on three quantitative factors. They start with free cash flow; we are really focused on trying to find companies that have good long-term prospects and are sustainable because it’s so difficult now to just take corporate gap reports at face value with so much discretion determining them.”
Theodore believes free cash flow is a more reliable indicator than simply going on what management tells his firm. He says that the second factor, strong balance sheets, completes the package when looking for a higher quality company.
He said: “The last factor, since we are owners in these shares, is that we want fewer other owners, so we like it when the share count goes down.”
He added that having companies able to buy back shares without using debt gives investors a cushion when rates and inflation increase.
“That’s important because there is expectation that rates are going to rise,” he said. “Certainly short rates, the Fed is going to do it, and maybe long rates. There are a few signs that inflation is going to increase, not dramatically yet, but even in Europe they’ve started moving out of the deflation. There are also a couple of indications in the US that inflation is gradually picking up.
“We have the Fed reserve actually reducing its balance sheets so there will be more supply of bonds, so you would expect interest rates to rise. That would be a challenge for companies to buy back its stock that are using debt.
“To that extent we have a little edge. If things don’t go well and the economy is not as strong as people think, that’s also a bit of a cushion that will moderate some of the initial pressures.”
Related stories:
Why growth beats value for investors
Some serious considerations for Canadian investors
