Search for Canada's value stars avoids stocks with excessive debt

The Globe and Mail, Number Cruncher

By Peter Ashton

Friday, August 16th, 2018

In The Globe and Mail, Peter Ashton uses Strategy Builder to search for Canadian mid to large-cap stocks matching traditional value investing criteria including profitability, low debt, dividends and reasonable valuations.

What are we looking for?

Canadian companies with attractive fundamentals based on traditional value investing measures.

In July, North American stock markets continued their upward climb with many indexes surpassing or approaching their record highs set in January. However, the tech stock sell-off in the final days of July has caused many market watchers to wonder whether the market is finally signaling an end to the days of momentum investing and the start of a new phase where value investing strategies are poised to outperform.

The screen

We will be using Trading Central Strategy Builder to search for Canadian mid to large-cap stocks matching traditional value investing criteria including profitability, low debt, dividends and reasonable valuations. The results are numerically ranked based on how closely the stock matches each of the chosen criteria.

numbercruncher

We will start by screening for Canadian stocks with a market capitalization of at least $3 billion. This will limit our search to larger and more stable companies with correspondingly higher quality revenue and earning streams. Next, we will filter for debt-to-equity ratios of 1.25 or less. In an environment of rising interest rates, we wish to avoid companies with high levels of debt on their balance sheets. Excessive debt is a drag on earnings and is avoided by value investors.

To zero in on companies with profitable operations, we will specify an operating margin of 10 per cent or more. Operating margin is a measure of how much profit the company makes on each dollar of core revenue. Higher operating margins are preferred.

To find companies with reasonable valuations, we will also filter for trailing price-to-earnings ratios of 18 or less. We use trailing rather than forward P/E ratios to remove the dependency on analyst earnings estimates in the event of a change in market conditions. Last, we will also screen for companies offering a dividend yield of at least 2.5 per cent. Value investors prefer companies that pay a dividend since they offer a stream of income while we wait for our investments to appreciate.

What did we find?

Topping our list is CI Financial Corp., a diversified wealth management firm and one of Canada’s largest investment managers. CI stock has had a terrible performance in 2018, down more than 23 per cent year-to-date. The low stock price has resulted in a trailing P/E ratio of just 11.4 and a dividend yield of 6.2 per cent, the highest on our list.

Canadian forest products companies have done well in 2018 despite U.S. tariffs imposed on some products. Norbord Inc. is a Toronto based provider of oriented strand board used in the construction industry. After hitting a 52 week high in June, the stock price has dropped about 19 per cent, leaving the company with strong fundamentals and a very low P/E ratio of just 6.5 and a dividend yield of 5.1 per cent.

Telecom giant BCE Inc. also makes our list, ranked at No. 4. BCE stock has also had a rough time in 2018, down almost 12 per cent year-to-date. Over the past two years, rising interest rates have pushed investors away from income stocks such as BCE and toward more risky growth stocks. However, in July we saw a reversal in this trend with BCE and other utilities rallying strongly as investors sought to derisk their portfolios.

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The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.

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