By Jason Moschella

Comparing and contrasting large Canadian and U.S. banks

Global financial stocks have surged over 125% since bottoming out in March. In the U.S., financials have more than doubled and in Canada they have rallied over 90%. We believe that while financial stocks across the globe may still have more upside as the economy levels off and deal flow picks back up, discrimination will be instrumental going forward. Consistent with this, our favourite picks, which we feel offer the best risk/reward profile, are the large Canadian banks. Indeed, all of the “big five” Canadian banks -- Royal Bank (RY), CIBC (CM), TD Canada Trust (TD), ScotiaBank (BNS), and Bank of Montreal (BMO) -- are on our “Strong buy” list and are well-positioned to beat the market over a 3-12 month time horizon. This compares to the wide variety of ratings for U.S. banks, which range from “Strong buys” for Bank of America (BAC), J.P. Morgan (JPM) and Wells Fargo (WFC), to “Strong sells” for Citigroup (C) and Suntrust (STI).

Investors have been extremely averse to buying back into the tech sector after getting burned in the wake of the technology bubble bursting back in 2000-2002. Although prices have rebounded since then, shares in this sector have, in general, failed to generate excitement. With the exception of crowd-pleasers such as Google (GOOG) and Apple (AAPL), technology shares have essentially “missed” this cycle and have performed roughly in line with the broad market. However, the stars are beginning to re-align and technology shares may benefit from key emerging secular trends that will likely change the business landscape in the years to come. Indeed, several big name technology companies such as IBM (IBM), Texas Instruments (TXN), Hewlett-Packard (HPQ), Oracle (ORCL), and Cisco (CSCO) are on our “Strong buy” list, and are well-positioned to beat the market over a 3-12 month time horizon.

On Wednesday, Seattle’s Best, a wholly-owned subsidiary of Starbucks (SBUX), rolled out "Just Pure Flavor," a new line of flavour essences for coffee-based beverages. The move is consistent with Starbucks’ recent efforts to diversify revenues away from retail stores and focus more on home-based consumption. In an environment where consumers are thinking twice about splurging on $5 lattes, Starbucks definitely “gets it”, and continues to show that they are nimble in adapting to new trends in consumer behaviour. The stock closed above $20 for the first time since January 2008, and we believe that there are many reasons to expect more upside in the months to come.

Lower coffee prices and rent expenses = higher margins

Companies with large amounts of cash have a greater ability to withstand the pressures of a recession and are well positioned to expand their businesses through takeovers if such opportunities present themselves. However, we believe that an analysis of a firm's cash position would be incomplete without also considering their debt burden. As a result, we have conducted a study of firms with large cash on hand and subtracted total liabilities to determine their net cash position. More precisely, we define the net cash position as Cash & Equivalents + Short-Term Investments - Total Liabilities.

The list below shows 20 of the largest firms with high net cash. These stocks should not be blindly purchased. Rather, investors can use this list as a starting point. Ideally, investors should try to determine what growth opportunities are available to these firms if that is possible. If growth opportunities exist (i.e. there are potential takeover targets) within their respective industries, then the excess cash (possibly combined with additional debt) can be put to good use. In addition, investors should consider valuations, qualitative factors along with industry competition.

We conducted a study looking for stocks with solid spring and summer seasonal track records starting in 1990 through today. Our findings were quite impressive and suggested that even during the so called “sideways” summer months, there are still stocks who persistently delivered positive returns year after year during this period. In all 6 examples, the stocks climbed at least 79% of the time during their respective strong seasonal periods. In all cases, these stocks are graded as Strong Buys or Buys by our Ranking System.

Food for thought.

Despite Monday’s 4% drop in Adobe's ADBE stock price, the stock remains roughly 45% above its March low. Our research suggests this stock has a lot more room to run over the next several months.

Dating back to the late 1990s, ADBE’s stock (adjusted for dividends and splits) has been correlated with the 12-month rate-of-change of software pricing power (note: we show consumer software prices as a proxy for overall software prices, i.e. business and consumer products). However, since last September ADBE’s stock price has diverged from software prices, a trend that we expect will reverse in coming quarters given the firm’s decent business prospects.

Companies with high leverage ratios stand to make good profits in booming economic times, as they can afford to maximize their output to meet budding demand. However, they are more vulnerable during recessions when sales typically slow and can be insufficient to cover interest expenses. During periods of slow or negative revenue growth, massive interest expenses can also lead to volatile earnings results from one quarter to the next, making the stock less popular among investors.

The chart below highlights 4 of the 10 companies we’ve chosen to highlight whose long-term debt/equity ratios have climbed substantially in the last year and are high relative to their historical average.

Prior to Monday’s large price decline, Macy’s (M) stock had jumped almost 50% since its March low. Contrary to popular belief, our analysis suggests it has more upside. It has accumulated hefty free cash flow suggesting it should be able to meet its debt obligations and maintain its dividend payments, a boon for investor confidence. The second highest revenue earner in the department store industry still has a positive ROE and boasts the third widest net profit margin in its group.

Meanwhile, the chart below demonstrates how Macy’s quarterly stock price momentum is inversely correlated with its quarterly inventory growth (inventory growth is shown inverted). This makes sense since leaner inventory levels imply that the firm is incurring less storage costs, and vice versa.