The majority of the world’s stock markets have seen an unprecedented recovery from the Covid crisis in 2020.
Most of the world markets are currently either overvalued or filled with euphoria. Thus, value investors are looking towards countries with reasonably valued markets.
One such country is Canada. The Canadian stocks market is an interesting place to invest right now because of the cheaper valuations as compared to the US and global markets and better dividend yields.
Canada hasn’t been as good a performer in the past few years, but now, it’s kind of starting to catch up with the broader trend.
It makes Canadian stocks an ideal place to look for value. Today, we’ll be telling you, the value investors, where the value exists in the Canadian marketplace, and even the specific stocks you should look to invest into.
We’ll also learn from someone who’s an expert in the Canadian stock market. Kim Shannon is the president, founder, and CIO at Sionna Investment Management, one of the largest investment firms led by a woman.
So, let’s first jump right into Kim’s definition of value investing and how to go about value investing in 2021.
What is Value Investing and How To Go About It
Value investing is all about buying a valuable asset at a reasonable price. In technical terms, it is the strategy in which you try to buy securities that are currently undervalued and have the potential to outperform.
There are various strategies that you can apply in value investing, but at the core, every strategy is about determining what the long-term true net worth of a stock is, and then trying to buy it well below that fundamental long-term value.
There’s a belief, and we’ve seen it over time, that stocks do what’s called reversion to the mean. They tend to go back to where they’ve tended to be in the past, meaning their fundamental value.
So if you’re able to buy the stock when it’s trading significantly below the mean, and wait patiently enough, then the stock will move back or revert to its mean, creating good reasonable returns for its investors. It is the most basic form of value investing.
To identify when a stock is trading below its true fundamental value, you must understand that the stock market is as much about human emotions as it is about fundamentals.
human emotions are a very significant part of returns in the market. When an investor can correctly catch the emotions in the market, they can easily grasp the overall picture of what’s playing out.
Because emotions are what takes the market to euphoric highs and depressing lows, creating opportunities for value investors to buy and sell, far away from the mean.
The whole market is about people. It is the people who create the prices in the stock market, not some algorithm, robot, or God. Checking human emotions is like checking the nerve of the market. It can tell you a lot about what’s going on.
Another major element that can help you become a better value investor is looking at the financial market history.
Yes, there are new inventions and new technologies in the marketplace, but history is still important because human emotions have not evolved. They are still the same and play the same crucial role in the market.
Humans are prone to repeating their past mistakes, and the financial market’s history tells you exactly how human beings, collectively, have made mistakes in the past that we’re likely to repeat in the future.
Now, contrary to popular belief, looking at history is not just about technical analysis or looking at decade-old charts. It’s more than that. For example, understanding when human beings have speculated a lot in the past and how that played out.
Why Canadian Stocks
As mentioned, the Canadian marketplace is an inexpensive marketplace relative to both the US and the global benchmark. It is currently trading at much cheaper PE multiples than the other major markets.
Also, it is trading with an expected 10-year return of about four to six percent average return, whereas the US and global benchmarks, given PE multiples north of 20, are offering expected returns closer to one.
Today, the overall US market is trading at a PE in the mid-20s, and history always suggests that when you have that rich a PE multiple, the subsequent 10-year return tends to be sub-par.
In addition, Canada has a one percent better dividend yield than either of those two major markets, meaning you’re getting paid to wait, and you’re getting a better future expected return.
Those are a few reasons why Canada is a place you might want to explore further from an investment point of view.
Best Canadian Sectors to Look Into
Canadian marketplace is comparatively cheaper, but it doesn’t mean that every stock or every sector is trading at reasonable valuations.
The entire market is composed today of 11 different industry groups or sectors. And at any point in time, some sectors are very richly valued while others are not.
For example, the tech space is currently pricey, not all elements of it but a majority of them. On the other hand, financial services are at pretty reasonable values.
As value investors, our job is to try and find the cheaper places in the market and invest in them because the price you pay when you enter an investment has a significant impact on your long-term returns.
Even in history, they’ve divided the market into two groups- the most expensive slices and the cheapest slices. The cheapest slices of the market historically trade somewhere between a 5 to 10 PE multiple.
How to Identify Value Stocks
Different value investors have different definitions of value and value investing. And they have different metrics by which they measure if an asset is undervalued or not.
According to Kim, what you should do is look at the history of a particular stock and how it’s tended to trade relative to the market throughout its history.
Classically, value investors like to look at the price to earnings multiple or price per pound or price to book ratio, etc.
Another major value metric is the price to cash flow, meaning the inflow of funds or cash generated by the company through its operating activities.
The dividend yield is also something you can consider as a value metric. The richer the dividend yield, the more defensive the stock.
Those are all indicators that you can use to tell whether that stock is cheaper than it has historically been or not. Then, take into account how risky the stock is and how likely is it to disappoint.
Taking all these elements into account, try to build a portfolio of relatively cheap stocks that have a better prospect of getting an above-average return in the future.
It’s always good to anchor on what the historical average returns are in markets, so you can get an idea of what your minimum return should be.
Best Canadian Stocks
If you dive into the Canadian marketplace, you’ll come across a lot of interesting names. Here, we’re telling you some of those names that you can start to look into:
1. Suncor Energy (TSE: SU)
A very large-cap oil and energy company based out of Canada. It is offering a great expected return right now.
The Toronto Stock Exchange witnessed a big move in the energy sector last year, and the commodity prices have also recovered dramatically from negative to $70 a barrel today.
While some stocks have recovered more, Suncor, in particular, really hasn’t moved with that commodity price yet. So there is more upside, according to Kim, in a name like Suncor.
2. Bank of Nova Scotia (TSE: BNS)
A banking stock that Kim and her company have an eye on is Bank of Nova Scotia, a well globally diversified Canadian bank.
The stock is currently lagged compared to some of the other major banks in Canada, and it has an opportunity to play a little catch-up.
It also has a fairly rich four percent dividend yield, which might attract some defensive value investors towards it.
3. Financial Services Sector
I know this is not a stock. But the whole financial service sector in Canada, both banking and insurance, is attractive right now.
The whole sector, including many big names, is trading at low PE multiples but still has above-average dividend yields.
Some value stocks from the financial service sector include iA Financial Corp., Fairfax Financials, and a life insurer called Manulife Financial.
What About Marijuana Stocks
It’s hard to ignore the Marijuana sector while talking about the Canadian stock market because the country legitimized marijuana earlier than the US, and it now has a publicly listed market earlier than anyone else.
The sector took off quite dramatically in advance of the legalization of cannabis, and it became quite speculative and overvalued very soon. And not after a long time, it came down as dramatically as it went up.
According to Kim, the sector again looks overvalued because now a lot of American investors are taking interest in it.
Since the price you pay when you enter an investment has an enormous impact on your long-term returns, investing now would mean overpaying for it.
So, Kim won’t recommend you get into the cannabis stocks at the moment and wait until the value is visible. Until then, you can look into some other best Canadian stocks that we’ve mentioned.