NVIDIA Corp. was dubbed ‘The Smartest Company in the World’ by the Massachusetts Institute of Technology in July 2017 and currently its stock is trading 37 per cent lower than its Oct. 1, 2018 high. This makes the semiconductor provider an attractive target for research with an eye to buying a position, so that’s what I’m doing. (Disclosure: based on the story linked above, my wife bought a position in NVIDIA although not at my suggestion – I thought the stock was too expensive at the time).
The company’s market position remains enviable relative to its competitors. NVIDIA’s graphics processing units (GPUs) dominate the rapidly-growing and profitable video gaming industry, and are now being applied to artificial intelligence, ‘vision’ for robotics and also autonomous vehicles.
The recent sharp swoon in the stock price was caused by a combination of slower global economic growth, a collapse in demand for the company’s products used for cryptocurrency mining, and the U.S. China trade dispute. These factors combined to slow sales and create a big jump in unsold semiconductors held in inventory. Inventory builds also negatively affected competitor firms like Advanced Micro Devices Inc., Micron Technology Inc., and Intel Corp.
On March 20, a research report by Citi analyst Atif Malik noted that NVIDIA’s inventory correction in the gaming sector, where the company generates 44 per cent of revenue, will be over by the end of March, which is potentially a positive catalyst for the stock price.
Piper Jaffray analyst Harsh Kumar is also bullish on the stock, initiating coverage with an overweight rating on March 26. Mr. Kumar wrote, “gaming is primed for growth in the second half of the year, as we see gaming growing year-over-year from its US$1.4 billion run-rate. We also see the data centre [cloud computing] and automotive markets as two long-term secular growth markets.”
Merrill Lynch quantitative strategist Savita Subramanian publishes an enormous report every year selecting the most applicable valuation multiple for each market sector, based on 25 years of performance history. For the broader technology sector, Ms. Subramanian believes Enterprise Value (EV) to Free Cash Flow is the valuation technique with the best chance of success .
The current EV/FCF ratio is 29.2 time which compares favourably to the near-50 levels of early 2018 when the stock was flying high.
Gross profit margins are, for me, an important indicator for technology stocks as a measure of growing market share. A deteriorating profit margin was among the early signs that Blackberry Ltd. (then Research in Motion) was losing out to Apple in the handheld device market.
The most recent gross margin result for NVIDIA in January was 54.7 per cent. This is a decline from mid-2018s 64.5 per cent which is cause for concern. I also checked the price to forward earnings estimate ratio, which is now at 28.4 times, much more attractive than 40.5 times in January 2018.
Ok, so this is a decent start on NVIDIA research. Thematically, I am a big believer in video game-related investing, as I’ve written previously. In my initial column on NVIDIA (link above), I proposed the stock as a proxy for the expansion of artificial intelligence. On that front there’s reason for optimism but there’s also the risk that, like 3D printers, a highly touted technology investment theme remains a fringe industry.
There is plenty more work to do on valuation, most importantly assessing the reliability of future growth projections. The initial glance sees the stock appropriately valued, or at least in the right ballpark given the seemingly strong longer term growth prospects and strong market position.
Based on the details above, there’s no conclusion to be drawn about whether to buy NVIDIA or not (this is also my way of telling readers that if they buy the stock based on this newsletter, they’re on their own). But hopefully it provides some insight into how I personally go about researching prospective investments.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Curaleaf Holdings Inc. (CURA-CN). Last week, this company’s share price spiked higher after management announced a distribution agreement with U.S. drugstore operator CVS Health Corp. (CVS-N) with management’s “hope to cement” additional national deals later in the year. Headquartered in Vancouver, Curaleaf is a cannabis company with dispensaries in 12 U.S. states, including Arizona, California, Connecticut, Florida, Maine, Maryland, Massachusetts, Nevada, New Jersey, New York and Oregon. The company anticipates expanding into two additional states later this year - Ohio and Pennsylvania. Jennifer Dowty reports (for subscribers).
Minto Apartment Real Estate Investment Trust (MI.UN-T). This REIT appeared on the positive breakouts list (stocks with positive price momentum) on Monday when the unit price closed at a record high. Analysts are anticipating this REIT will deliver a potential price return of 10-per-cent over the next year. It also has eight buy recommendations from analysts. Ottawa-based Minto Apartment REIT owns a portfolio of 24 rental properties with a total of 4,548 apartment units. The majority of the properties are located in Ottawa. Other cities where Minto has a presence include Toronto, Edmonton and Calgary. Jennifer Dowty reports (for subscribers).
Why the TSX is doing so well this year despite the stalled economy
As the signs of domestic economic weakness pile up, the Canadian stock market is curiously resilient. Investors have been pummelled with a barrage of bearish indicators so far this year, from a stalled economy to record household debt to plunging corporate earnings estimates to bond-market red flags. And yet, Canadian equities are off to their best start to a year in nearly two decades, with the S&P/TSX Composite Index clinging to a lofty 12-per-cent gain, even as falling long-term bond yields stoked global recession fears and stirred up market volatility over the past couple of trading days. While the stock market and the broader economy tend to move in the same direction over the long term, it’s not unheard of for the two to diverge significantly. Tim Shufelt reports (for subscribers).
Don’t be so dismissive of The Big Short’s bet against the Canadian banks
U.S. hedge fund manager Steve Eisman became famous through his depiction in Michael Lewis’s financial crisis book, The Big Short, which detailed the manager’s successful shorting of markets before the crisis hit. Mr. Eisman is now infamous in Canadian investing circles after reports, initially in the Financial Times, said he has built short positions against Canadian bank stocks. It’s not the potential success or failure of the bet against banks Scott Barlow wants to discuss anyway, it’s the dismissive reaction he’s been seeing on social media such as Twitter from Canadian investors – “Good luck with that, Loser” is not a huge exaggeration – that interests me most. He says he has a relatively vivid imagination but can’t foresee any situation where any of the major Canadian banks, with the Bank of Canada standing behind them with the ability to print money, will experience anything close to insolvency. That said, one of the primary lessons of the financial crisis is that, at the end of an unprecedented credit cycle, no company is immune. (For subscribers).
How fees and taxes can ruin your retirement
The stock market produced big gains in the past and investors dream about retiring on similar returns in the future. But their plans might be ruined because the market’s gains do not include some major costs. When planning for retirement, many people start with the 4-per-cent rule. It was popularized by financial planner William Bengen in a 1994 paper called Determining Withdrawal Rates Using Historical Data. He figured that, for a balanced portfolio of U.S. stocks and bonds, a 4-per-cent initial annual withdrawal rate, subsequently adjusted for inflation, could be maintained safely for at least 30 years without running out of money. Those who work hard and save up the required $1-million to satisfy the 4-per-cent rule to allow for $40,000 worth of real annual withdrawals might breathe a sigh of relief. But they shouldn’t because they’ve just reached the thin line between failure and success. Sure, with a little luck, they’ll have a happy retirement. But that possibility might come to naught because it doesn’t include costs encountered by most investors. The 4-per-cent rule includes inflation, but it does not factor in fund fees and taxes, which can be sky high. Norman Rothery takes a look at the numbers (for subscribers).
Why value investors shouldn’t give up quite yet
Value investors just can’t catch a break. Their latest blow was last week’s change of heart by the U.S. Federal Reserve. The Fed’s sudden and surprising conversion to dovishness adds to a decade of disappointment for dedicated value hunters. Their strategy emphasizes buying shares that are cheap in comparison with underlying fundamentals such as sales and earnings. In theory, it is an eminently sensible approach to picking stocks. In practice, it has flopped since the financial crisis. For years now, value stocks have lagged behind the broad market. Ian McGugan reports (for subscribers).
How this business analyst built herself a dividend portfolio and retired early
These days, many investors are building portfolios of dividend stocks in hopes of becoming financially independent well before age 65. Susan Brunner has been there, done that. She began investing during the 1970s and ended up with a dividend portfolio that enabled her to leave the work force in 1999, when she was in her early 50s. The Globe and Mail’s Larry MacDonald recently interviewed Ms. Brunner, now in her early 70s, about her 40 years of investing and 20 years of retirement. (For subscribers).
Cashless society series:
In a cashless world, society’s most vulnerable are being left behind
It’s hard for Carl Stinson, 53, to imagine a world without cash. Mr. Stinson, who lives at the Good Shepherd men’s shelter in Hamilton, doesn’t have a bank account and has panhandled to pay for necessities. These days, he receives social assistance, doled out in weekly cash increments by a trustee at the shelter. With people increasingly choosing plastic and carrying less cash in their pockets, Mr. Stinson is worried society’s most vulnerable stand to lose out. “If [people] are not on assistance and they don’t work, how are they supposed to eat if they don’t panhandle?” he says. “[Panhandlers] will suffer... The whole society will suffer. Thank goodness for the people in society who put money in a cup.” Saira Peesker reports.
Others (for subscribers)
Others (for everyone)
Ask Globe Investor
Question: Now that the federal government is targeting swap-based exchange-traded funds (ETFs), do you think they will do the same thing to covered-call ETFs? These ETFs pay a high yield that is tax-friendly and I am concerned that the revenue-hungry government will go after them next.
Answer: No, covered-call exchange-traded funds are almost certainly not in the government’s crosshairs.
In this week’s federal budget, the government specifically took aim at funds that use a method that “inappropriately defers tax or converts fully taxable ordinary income into capital gains taxed at a lower rate.” It also pledged to tighten existing rules “meant to prevent taxpayers from using derivative transactions to convert fully taxable ordinary income into capital gains taxed at a lower rate.”
One of the government’s main targets is swap-based ETFs, which defer tax to unitholders by effectively converting dividends and other income into capital gains that only become taxable when the units are sold. These products, also known as total return ETFs, are popular in non-registered accounts because they deliver the same total return – including dividends – as the index they track while avoiding the annual tax hit.
But covered-call ETFs are a different animal. These ETFs generate additional income by selling (or “writing”) call options on a portion of their underlying securities. A call option gives the buyer the right to purchase the shares at a specified price before a specified date. They’re known as “covered” calls because the ETF owns the stocks on which the option contracts are written.
Because covered-call ETFs collect premiums when they sell options, they can pay a higher yield than an ETF that doesn’t use a covered-call strategy. It’s not a free lunch, however, because in a rising market, the ETF will often have to sell stocks to the option holder at the agreed-upon price, which limits the upside potential of the ETF.
But unlike swap-based ETFs, covered-call ETFs don’t defer tax. The premium income is paid out to unitholders and taxed as capital gains in the year it is received. Dividends and other income are also paid out and taxed annually, so there’s little incentive for the government to go after these products.
“The proposed changes in the legislation had absolutely no impact on any covered-call strategies in Canada,” Mark Noble, senior vice-president with Horizons ETFs Management (Canada) Inc., said in an interview.
Horizons has published a list (bit.ly/2Ofg7Zm) of several dozen ETFs – including derivative-based products that let investors bet on the direction of commodities – that could be affected by the proposed legislation, but none of Horizons’ eight covered-call “enhanced income” products was mentioned. Similarly, Bank of Montreal said six of its “TACTIC” mutual funds could be affected by the proposed legislation and the bank has therefore suspended new purchases of the products. But none of BMO’s covered-call ETFs was on its list, either.
“While I have never liked covered call funds – because they accept a good majority of the downside while giving up the vast majority of the upside – investors have nothing to worry about as a direct result of this week’s budget,” Dan Hallett, vice-president and principal with Highview Financial Group, said in an e-mail.
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What’s up in the days ahead
Day trading in a TFSA account? There are now some tax risks you need to know about. Clare O’Hara will report.
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Compiled by Gillian Livingston