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Rosenberg: Canada stocks trading at 'epic' discount to U.S.

Gluskin Sheff chief economist David Rosenberg.

Deborah Baic/The Globe and Mail

Canada's ability to outshine its neighbour to the south will extend beyond Olympic hockey this year, says David Rosenberg.

The chief economist with Gluskin Sheff says our stock market is trading at an "epic" discount to the U.S. and is poised to outperform.

His message to investors: start taking profits on U.S. stock holdings and redeploy the proceeds to more attractively priced Canadian stocks.

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A lot of his case rests on the PEG ratio. Popularized by legendary U.S. fund manager Peter Lynch, it's calculated by dividing the price-to-earnings ratio by earnings growth rates over a specified period of time. The lower the PEG ratio, the more a security or market may be undervalued given its earnings performance. Generally, a PEG ratio of 1 or less signals a potential buy for investors. A ratio well above 1 suggests a security or market is richly priced.

Inside the Market readers may recall that Mr. Rosenberg last November cited the disparty in the two country's PEG ratios as a reason to buy the Canadian market over the U.S. At that time, the TSX PEG ratio was near 1 - or fair value - and the S&P 500 was at 1.38 times.

Since then, the TSX has grown to become an even better buy relative to the U.S. using the measure. When looking at three year price-to-earnings against the three-year consensus earnings per share growth rates, the TSX PEG ratio is now 0.92 times. The S&P 500 is at a much higher 1.33 times.

"Now, I can either ask you to be the judge or I can ask you to do the arithmetic and you will see that the Canadian stock market now trades at an epic 30 per cent discount to the U.S.," Mr. Rosenberg said in his Breakfast with Dave daily research note this morning.

"In other words, time to start taking profits on that once-booming U.S. equity market and redeploy the proceeds in the more attractively priced Canadian landscape."

He notes that just about every sector commands a "superior" PEG ratio in Canada, including energy, financials, industrials, consumer stables and cyclicals.

If you want to go bargain hunting, he offers this lesson on using the PEG ratio: "Ultimately, equity investors seek to invest in growth. So if a company has a 20 P/E ratio but a 30 per cent earnings stream, it is actually an under-priced stock. You want to buy it. Its price/earnings-to-growth ratio or PEG is less than 1 (0.67 times) You are getting paid to take on that growth! Just as in reverse, a company may have a 10 times P/E multiple, and may look cheap. But if its future EPS growth is just 5 per cent per annum, then it commands a 2 times PEG and as such what looks cheap is rather richly priced."

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