What are we looking for?
Canadian stocks trading far above book value.
Earlier this week, we examined stocks trading for low multiples of price-to-book value. Our inspiration was research by Kenneth French, a professor at Dartmouth College, that shows low price-to-book-value stocks tend to produce unusually large returns.
The opposite has been the case for high price-to-book-value stocks. Prof. French's research shows that this group has tended to produce much smaller returns over time than more moderately priced counterparts.
Between 1926 and 2009, an annually rebalanced portfolio of stocks composed of the tenth of the U.S. stock market with the highest price-to-book ratios produced annual average returns of a mere 5.8 per cent, compared with 19.7 per cent for the stocks with the lowest price-to-book values.
History would therefore suggest that investors should steer clear of high price-to-book stocks. But remember that these stocks are trading far above book value for a reason: typically they are stocks the market loves. Avoiding them is a bet that the market is wrong.
We looked for stocks listed on the Toronto Stock Exchange trading at more than 10 times book value. To narrow our search, we required firms to have at least $150-million in market capitalization.
What did we find?
An interesting assortment of companies ranging from giants such as Extendicare Imax and Sprott Inc. to relatively small miners and technology developers.
Several of these companies don't have profits, but the market is still putting a rich valuation on their operations in anticipation of future gains. Those on our list that are profitable tend to trade for high price-to-earnings ratios, again suggesting that investors are building in high expectations.
Some of these firms will no doubt live up to expectations, but value-conscious investors may want to think twice before buying into companies with share prices that already reflect elevated hopes.
Ian McGugan