Free Cash Portfolio Strategy Delivers Market-Beating Returns Over 26 Years
As gardeners eagerly anticipate spring planting season, investors too can benefit from a well-cultivated strategy. The Free Cash portfolio approach, which seeks bargain stocks with substantial free cash flow, has demonstrated remarkable growth, achieving average annual gains of 16.9% over the 26-year period through February 2026. This performance starkly contrasts with the Canadian stock market, represented by the S&P/TSX Composite Index, which climbed at a more modest average annual rate of 8.1% during the same timeframe.
Understanding the Free Cash Portfolio Methodology
The Free Cash portfolio begins its search by examining the largest 300 stocks on the Toronto Stock Exchange, ranked by market capitalization. From this pool, it invests equal dollar amounts in the ten stocks with the lowest positive enterprise value to free cash flow ratios (EV/FCF). Enterprise value combines a company's market capitalization with its net debt, while free cash flow represents the theoretical amount of money available to shareholders after maintaining operations, approximated by subtracting capital expenditures from operational cash flow over the trailing twelve months.
Important note: The returns discussed are based on backtests using monthly Bloomberg data, incorporating dividend reinvestment but excluding fund fees, taxes, commissions, and other trading costs. Portfolios are equally weighted and rebalanced monthly unless specified otherwise.
Fixed-Ratio Approach: An Alternative Investment Strategy
Instead of adhering to a fixed number of stocks, investors can employ a flexible fixed-ratio strategy that allows portfolio size to vary over time. This approach begins with the same 300 largest TSX stocks but invests in those with EV/FCF ratios below specific thresholds: 5, 10, 15, or 20.
The fixed-ratio portfolios have consistently outperformed the market, delivering average annual gains of 16.9%, 15.7%, 17.2%, and 16.6% for ratios below 5, 10, 15, and 20, respectively, over the 26-year period ending February 2026.
Portfolio Composition and Historical Variability
The accompanying graph illustrates how the number of low-EV/FCF stocks in these portfolios fluctuated over the 26-year span. On average, the fixed-ratio portfolios contained 6.6, 27.8, 52.7, and 78.4 stocks for ratios below 5, 10, 15, and 20, respectively.
Notably, there was one month with no stocks meeting the EV/FCF ratio below 5 criterion, and holdings frequently numbered fewer than ten. Conversely, portfolios with ratios below 10 always included at least 11 stocks, while those below 15 consistently featured a minimum of 23 holdings.
By the end of February 2026, the number of low-EV/FCF stocks in the fixed-ratio portfolios was generally lower than the 26-year averages, except for the portfolio with ratios below 20, which remained close to its historical average. This assessment preceded market declines following geopolitical tensions, highlighting how external factors like conflict can impact inflation and stock market performance, posing risks even to robust strategies like the Free Cash portfolio.
Long-Term Prospects and Investor Considerations
The future trajectory of the Free Cash portfolio remains an area of keen interest for financial analysts. With prudent management and perhaps a measure of luck, this strategy may continue to thrive through subsequent market cycles. Investors are encouraged to stay informed by accessing detailed stock information and regular updates through reputable financial publications.
Norman Rothery, PhD, CFA, founder of StingyInvestor.com, emphasizes the importance of strategic planning in investing. For ongoing insights, consider subscribing to financial newsletters that deliver expert analysis directly to your inbox multiple times weekly, helping you make smarter investment decisions in an ever-evolving market landscape.
