Most of us are taught that "buy low, sell high" — which is adding undervalued stocks to the portfolio and selling them when valuations get expensive — is the secret to successful investing. For the past decade, this value-oriented approach has been a terrible, underperforming strategy.
In a July 17 research report, Merrill Lynch quantitative strategist Savita Subramanian calculated that value-oriented investors who bought the cheapest U.S. stocks, according to price-to-book value, generated a meagre average annual return of 2.3 per cent over the past five years. This compares poorly to growth investors who bought stocks with the highest projected earnings growth, who enjoyed an 8.5-per-cent annual return for the same period.
The underperformance of value strategies has Ms. Subramanian's institutional clients ignoring stock valuations entirely. "We hear frequently that valuation just doesn't matter anymore. Value factors have been summarily discarded," she says, noting that value stocks trade at a 20-per-cent discount relative to history.
Citi strategist Jonathan Stubbs says value stocks are as inexpensive, relative to overall market valuations, as they were in 2009. Compared with high-quality and low-risk market sectors, value stocks are cheaper than they've ever been.
That's where markets stand and there are two schools of thought as to what happens next: The obvious outcome is that markets revert to the mean as they did when the technology bubble imploded in 2000. This scenario implies that current conditions are merely an aberration and value stocks will shortly begin an extended period of outperformance while growth companies slide. The other school of thought is that traditional valuation techniques are outdated because of the modern economy. Sectors like biotechnology and software require minimal labour, do not invest heavily in plant and equipment, are thus far more profitable and deserve higher valuations.
Goldman Sachs U.S. equity strategist David Kostin published a chart earlier in the year showing that, whether they deserve it or not (Mr. Kostin was ambivalent on the matter), the stocks and sectors with the highest expected profitability in terms of return on equity have consistently higher price-to-book ratios.
I updated and reproduced the Goldman Sachs chart and posted it on social media. The relationship remains the same — high profitability gets a higher price-to-book value. Every S&P 500 sector, with the exception of real estate, is closely bunched around the trend line on the chart, suggesting a proportional relationship between return on equity and price-to-book value.
The current situation, as represented by Goldman Sachs, represents an equilibrium — a concept of fair value — but not necessarily a sustainable one. The market may in future years return to a valuation bias favouring companies with low price-to-earnings or low price-to-cash-flow where most stocks have multiples that fall within a narrow range.
- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Well Health Technologies Investors looking for a Canadian health-care play driven by new technologies are examining Well Health Technologies Corp., a Vancouver-based small-cap with a high-profile investor and mission to change how doctors work, writes Brenda Bouw (for subscribers). Shares of TSX Venture Exchange-listed Well Health, which own 19 family-doctor clinics in B.C. and a growing electronic medical records (EMR) business, have risen by about 230 per cent so far this year to a market value of around $142-million, or about $1.50 a share. The stock has pulled back from its all-time high of $1.87 on July 12 as the recent euphoria wears off. “There is greater awareness to the story,” GMP Securities analyst Justin Keywood says of the stock’s recent run-up. “Investors are starting to recognize what this business could become.”
Hamilton Thorne Ltd. (HTL-X): This stock appears on the positive breakouts list (stocks with positive price momentum). The share price of this micro-cap stock has rallied 455 per cent since the beginning of 2016 with its share price rising to over $1 from a share price of 20 cents. The stock price is up 23 per cent this year. The five analysts covering the company all have “buy” recommendations and the average one-year target price implies a potential gain of 38 per cent. The share price can be very volatile. Consequently, this stock is best suited for consideration by investors with a high-risk tolerance within a diversified portfolio, Jennifer Dowty reports (for subscribers).
BlackRock’s chief Canadian strategist on how to invest the rest of this year
While the S&P/TSX Composite Index staged a major comeback at the start of 2019 and is up approximately 15 per cent year-to-date, it’s relatively unchanged from where it was one year ago. Since the beginning of 2018, the S&P/TSX Index has repeatedly stalled around the mid-16,000 level. In the current environment, active portfolio management including sector rotation, stock selection and country and industry exposure diversification have become increasingly important for investors to employ in order to achieve attractive returns. The Globe's Jennifer Dowty recently interviewed Kurt Reiman, BlackRock’s chief investment strategist for Canada, on how investors may want to position their portfolios for the second half of 2019. (For subscribers).
TFSAs have been a disappointment in getting Canadian to save more
Everyone loves tax-free savings accounts – this is not in dispute, writes Rob Carrick. But how good are TFSAs for the country? He cites a recent study in the Canadian Tax Journal, which raises some doubts. “The key question that got us started in the first place is whether TFSAs really help Canadians to save more, as the government intended them to do,” said Lu Zhang, an assistant professor of finance at Ryerson University’s Ted Rogers School of Management and a co-author of the study. “What we found is that this isn’t quite the case. ”The issue with TFSAs is that they’re vacuuming up money that would otherwise have gone into registered retirement savings plans. The study calls this a “displacement effect.”
'One of the most puzzling' economic landscapes ever: How a low-rate world is baffling investors and CEOS alike
In what a prominent chief executive calls “one of the most puzzling” economic landscapes he has ever seen, the unusual is quickly becoming the usual – and few things demonstrate that better than the expectations surrounding the U.S. Federal Reserve meeting at the end of this month, writes Ian McGugan (for subscribers). Central banks usually reduce interest rates to stimulate economies that are fading, but the Fed is now nearly universally expected to cut rates at its meeting July 30 and 31. Cutting interest rates would be a remarkable move at a time when the U.S. economy appears to be in the pink, with unemployment hovering around multidecade lows and stock markets hitting record peaks. The futures market sees a 69.5-per-cent chance of a standard quarter-percentage-point cut and a 30.5-per-cent probability of a more dramatic half-percentage-point chop. The anticipated cut would speak to how radically thinking has shifted after a decade in which inflation has remained stubbornly low across the developed world despite declining unemployment.
A growth-oriented RRSP portfolio that's simple and smart
ETFs holding a diversified blend of investments have been around for 18 months or so, but we’re still learning about the many ways to put them to work, writes Rob Carrick (for subscribers). He discusses a strategy from a reader that’s “both simple and smart at the same time.” It’s the combination of a diversified exchange-traded fund holding all stocks with a guaranteed investment certificate. Mr. Carrick acknowledges that balanced ETFs are supposed to be a fully diversified portfolio in a single package, with both stocks and bonds. But he says the strategy might be of interest to investors who like to get exposure to stocks with ETFs but prefer GICs as a substitute for bonds.
Others (for subscribers)
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What’s up in the days ahead
Following a push from regulators a year ago, online brokers are getting better at providing access to funds with lower fees than those sold by investment advisers. Rob Carrick will explain this weekend.
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