After lagging the S&P 500 since 2010, the S&P TSX Composite Index, the main benchmark for equities in Canada, has performed well against the S&P 500 in 2014. As shown in graph 1 below, the YTD performance of the TSX is 10% vs. 6% for the S&P 500. This sharply contrasts the underperformance of the TSX during the last 5 years, as shown in graph 2.
I believe the TSX should perform well in 2014, given it has lagged the S&P 500 by over 100% since 2009. Given this conclusion, which companies should investors add to their portfolio?
This article will provide a screen that will search for cheap companies with high profitability. The added consideration will be on dividend yield, since investors place a high emphasis on income when interest rates are low. Because the Fed and the Bank of Canada are sticking to their dovish monetary policy, it is likely rates will stay at the zero lower bound until 2015.
Graph 1: TSX vs. S&P 500 Performance (YTD):
Source: Yahoo Finance. ^GSPTSE is the ticker for the TSX Composite on Yahoo Finance, while ^GSPC is the ticker for the S&P 500
Graph 2: TSX vs. S&P 500 Performance (5 Years):
Source: Yahoo Finance
The screening criteria are relatively simple, as shown below:
- Market Cap
- Return on Equity (5-year average)
- Price-to-Earnings Ratio
- Dividend Yield
I screened for market cap greater than US$2 billion to provide names that are both more stable and more accessible to US investors. The ROE requirement put emphasis on profitability and efficiency. Moreover, the price-to-earnings ratio ensures that the companies are trading at a cheap level. Given 10-year Canadian bond yield is near 2.25%, I want to screen for companies that have an earnings yield (earnings/price) of 3 times that amount, which implies a price-to-earnings ratio below 15.
Screening Result for Companies:
The results of the screen are shown below. Eleven are financials, with the big 5 banks all on the list. I am not surprised that all big 5 banks were on the screen, because they all still trade between 11-13 times earnings and earn ROEs in the high teens, which allowed them to pass the screen with ease. For investors wishing to be more selective regarding the banks, please see my prior articles. I still favor TD and Bank of Nova Scotia for their lower Canadian exposures and better growth potential. I believe having 2-3 bank names in a Canadian portfolio is key to providing dividend growth and price appreciation.
Other than the big 5 banks, the other financials names include National Bank of Canada (a smaller bank than the big 5), Power Financial (a holding company), Great-West Life (Life Insurance), Industrial Alliance (Life Insurance), Home Capital Group (Mortgage lender) and Genworth Canada (Mortgage Insurer). National Bank is an interesting bank name to add to a portfolio, given its excellent operating track record in the past 2 years. It is also expanding into wealth management, which is a higher margin business. Power Financial is another interesting name to look at, because it holds large stakes in various entities, including Great-West Life (67% stake), IGM Financial (100%) and Parjointco (55% stake), which holds stakes in Total (NYSE:TOT), Lafarge and Pernard Ricard. I would be cautious with mortgage related names, such as Home Capital and Genworth, because a housing correction could negatively impact their stocks. Also, given that both stocks have performed well in the past 12 months, it is better to invest in life insurers like Industrial Alliance or in a holding company like Power Financial, which controls Great-West Life.
Five names in the screen are REITs. Investors should be careful when selecting REITs, because it is essential to separate the wheat from the chaff. REITs with growing Funds From Operations like Canadian Apartment REITs, shown in the screen, should perform well even if the interest rate increases.
Other than financials and REITs, two names that attracted my attention are Agrium and Rogers. Agrium was impacted when the Potash cartel broke down last year and drove down the potash price. However, it has a valuable retail operation, and its potash business is relatively small. Regarding Rogers, it was a name that got hit hard in the past year, as wireless growth slowed down due to intense competition. Nonetheless, Rogers should still perform well in the future, given it possess a portfolio of excellent assets and brought on board a veteran CEO to turn the operations around.
One final name I would like to point out is Bombardier. I used to own the stock in my portfolio, but sold out last summer because it reached my intrinsic value estimate near $5.25. It may become a deep-value play only if the price declines further near $3. The company still has problems in its aerospace business, but investors should not forget it also owns an excellent rail business that shouldn't be ignored.
Table 1: Screen Names
Source: FT Equity Screener. Names include Agrium (NYSE:AGU), Allied Properties REIT (OTC:APYRF), Bank of Montreal (NYSE:BMO), Bank of Nova Scotia (NYSE:BNS), Bombardier (OTCQX:BDRBF), Boardwalk REIT (OTCPK:BOWFF), Canadian Apartment REIT (OTC:CDPYF), Canadian Imperial Bank of Commerce (NYSE:CM), Canadian Oil Sands (OTCQX:COSWF), Cominar REIT (OTC:CMLEF), Corus Entertainment (OTCPK:CJREF), Dream Global REIT (OTC:DUNDF), Genworth MI Canada (OTC:GMICF), Home Capital Group (OTCPK:HMCBF), Industrial Alliance Insurance (OTC:IDLLF), Labrador Iron Ore Royalty (OTCPK:LIFZF), National Bank of Canada (OTCPK:NTIOF), Power Financial Corp. (OTCPK:POFNF), RioCan REIT (OTCPK:RIOCF), Rogers Communications (NYSE:RCI), Royal Bank of Canada (NYSE:RY), and Toronto-Dominion Bank (NYSE:TD).
The Bottom Line:
Because equity markets are on the higher end of the valuation scale, investors should be careful when adding stocks to their portfolio. This article provides 23 Canadian names that warrant additional research. Best of luck to everyone in the hunt for cheap and profitable stocks.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. The stock mentioned in this article does not represent financial advice. Investors are recommended to conduct further due diligence before committing capital to any investment.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.