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BNN Market Call – January 11, 2018 – Past Picks

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DANAHER CORPORATION (DHR.N 0.36%)

Is a conglomerate focused on five areas: life sciences, diagnostics, water quality, product ID and dental. Each has high barriers to entry. The company acquires firms and changes the business structure to reduce costs and increase margins, providing solid free cash flow growth which leads to higher annual dividends and, ultimately, a higher long-term share price.

  • Then: $87.50
  • Now: $98.56
  • Return: 12.64%
  • Total return: 13.36%

PAYCHEX (PAYX.O 1.01%)
Provides comprehensive payroll and integrated human resource and employee benefits outsourcing solutions for small-to-medium-sized businesses in the United States. For every quarter of a percent increase in rates, the company makes US$3M or US$0.01 a share in profits just by investing the float set for remittance to the IRS from payroll taxes. The recent corporate tax cut from 35 per cent to 21 per cent should provide Paychex with ample cash to continue raising its dividend aggressively.

  • Then: $62.56
  • Now: $66.86
  • Return: 6.87%
  • Total return: 9.50%

Dassault Systemes (DSY.FP)
Provides a variety of computer-aided design, manufacturing, engineering and product lifecycle management (PLM) software that firms use to create, model and test designs. From original idea to finished product, Dassault’s software is the creative tool. Recent acquisitions have included firms with artificial intelligence experience to further improve the design experience for their clients.

  • Then: $76.81
  • Now: $91.22
  • Return: 18.76%
  • Total return: 19.52%

TOTAL RETURN AVERAGE: 14.12%

BNN Market Call Tonight – Janaury 11, 2018 – Market Outlook

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DAVID DRISCOLL’S MARKET OUTLOOK

Are we in for a wild ride in 2018? With the S&P 500 Index currently trading at 23.14x earnings and its historical average at 16.2, one may surmise the market is 43 per cent overvalued. However, according to history, the largest market peaks in 1929 and 1999 suggest we could go another 40 per cent higher – the “melt-up phase.” Unfortunately, the ride down to its historical norm after such a peak would be about 50 per cent.

So, what to do? Here are some ways to deal with today’s markets:

  • Re-balance positions when necessary – if you own a 30-stock portfolio and one of the holdings becomes greater than six per cent, sell half and allocate the cash to those positions with a weighting less than three per cent. This avoids any emotional struggle – instead it’s mechanical.
  • Pay attention to the stock’s beta – if you own stocks with betas over 1.50, it’s important to either sell outright or re-balance. That’s because if the market drops 50 per cent, these stocks could drop 75 per cent (50% x 1.5). That could destroy your capital quickly and the return to break-even could take decades.
  • Keep some money in cash. We hold 20 per cent times the equity weighting of a client’s portfolio. If the portfolio is 100 per cent equity, then we’re 80 per cent invested with 20 per cent in cash. If the portfolio is 50 per cent stocks and 50 per cent fixed income, we’d have a 10 per cent cash weighting (50% x 20%).
  • Diversify globally. If the market drops 50 per cent, the Canadian dollar will come under pressure and a global portfolio would help ease the pain. In 2008, the Canadian dollar fell 22 per cent as investors flocked from minor currencies like the Loonie to the more liquid currencies of the U.S. dollar, euro and the Japanese yen.
  • Avoid correlation risk – don’t own multiple stocks in the same industry. In 2008, it wasn’t one Canadian bank that fell 40 per cent, they all did. If you’re living off the capital and it falls 40 per cent, you could run out of money before markets recover.

Client Question: How do you invest to deal with the recent disruptive or destructive technology trends?

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While Amazon may get the most press for disrupting industries and economies around the world, there are plenty of companies making their own waves on this front. The way to go about investing on the right side of these trends is to think: what companies can Liberty investors own today that will still be around in 10 years to benefit from the growth in their free cash flow and dividends? And what sectors should be avoided?

The sectors we are currently avoiding are energy, telecoms and most utilities that don’t have much exposure to renewable energy.

Their growth could wane quickly – if it is 5, 10 or 15 years from happening, investors should do a discounted cash flow valuation of these stocks. If the valuation reaches that price, they should sell the stock.

Or they could face the “Last Man Standing” scenario, whereby the last purchaser of Nortel or Valeant stock at its peak saw the stock move only lower.

Below is a table of the current investment trends for the future. Unlike the bubble that burst in 2000 that sent technology stocks plummeting, these companies all have real and growing revenues, profits and free cash flows:

TREND LIBERTY STOCKS INVOLVED IN THESE SECTORS
Water A.O. Smith, Lindsay Corp., Danaher Corp.
Agriculture Agrium, Lindsay Corp., Raven Industries
Healthcare – Pharma Novo-Nordisk NV
Healthcare – Medical Devices Becton Dickinson, Atrion Corp., Coloplast A/S, Globus Medical, Stryker Inc.
Other Medical Balchem, Mesa Labs, Steris
Fintech Chubb, Fairfax, Great-West, TD Bank, First Cash Financial, Paychex
Robotics Cognex Corp., Danaher Corp
Life Sciences Danaher Corp., Thermo Fisher Scientific
Logistics Dassault Systemes, Roper Technologies
Artificial Intelligence Dassault Systemes,  Open Text, Shopify Inc., Cognex Corp.
Government Regulations Halma plc., Intertek Group, Spectris plc.
Renewable Energy NextEra Energy, Novozymes A/S
Infrastructure Toromont Industries, Stantec, Roper Technologies
Aerospace Heico Inc.,RBC Bearings
Automotive Computerization Littelfuse Inc.

Client Question: What kind of returns may I expect from my investments?

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The first thing investors need to understand is that risk and reward walk hand-in-hand. Therefore, the higher the risk, the higher the range the returns should be. Unfortunately, it works both ways – you may earn big returns or suffer big losses.

When considering the appropriate asset mix for your portfolio, check out the table below provided by The Vanguard Group. It considers Canadian equity and fixed income returns from 1985 to 2013.

On the far left is an asset mix of 0% equities and 100% fixed income. The range of returns for that mix is +21.2% to -4.5%. This mix would be appropriate for investors who want little to no risk as the greatest downside return is a 4.5% loss in any one year.

As you add equities to the mix, note that the range of returns increases. For a 50% stock / 50% fixed income portfolio, the range of returns widens from +24.6% to -13.0%. And for a 100% equity portfolio, the range of returns becomes the greatest, from +35.1% to -33.0%.

That’s why, generally speaking, those who invest all in equities tend to be under the age of 40 because they have time on their side to enjoy the compounding that 30-50 years provides.

Client Question: What do you think about the FAANG stocks?

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This year, the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) have enjoyed an average 47% return, well above the market averages. The reason we don’t own them is three-fold:

  1. They make up a large portion of the Dow Jones Industrial Index and the S&P 500 Index, meaning every ETF owns them. What you usually end up with is a reversion to the mean. The more shares that must be bought with each investor purchase of an index fund, the more the performance tends to follow an “average” return.
  2. Stocks like that usually signal their price peak before a precipitous fall. Just ask shareholders of Nortel, Royal Bank and Valeant. They once were the largest holding on the TSX Index but soon fell in value after the peak.
  3. We prefer to own stocks that aren’t widely held by investors. This gives us a chance to get in early. We can enjoy gains based on the company’s own performance and when they are added to an index or grow enough to attract more eyeballs to the stock, the returns can continue to rise at a greater rate for a longer time. In our US stock portfolios are 5 names that have outperformed the FAANG stocks this year:
FAANG Stocks 2017 Performance (YTD at 12/01/17) US Liberty Stocks 2017 Performance (YTD at 12/01/17)
Facebook 52% Cognex 115%
Amazon 55% Graco 55%
Apple 47% Globus Medical 49%
Netflix 51% Raven 47%
Google 29% Atrion 33%
Average Return 47% Average Return 60%
Data courtesy of Bloomberg LLP

Client Question: Why should I own foreign investments?

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Canada may be a great place to live but according to 2017 data from the IMF the Canadian economy makes up only about 1.4% of global GDP. By investing only in Canada you are turning down an opportunity to invest in the other 98.6% of the global economy.

Beyond that Canadians face two major problems at home:

  1. The TSX index isn’t diversified – financial and resource stocks make up 65% of the index. Remember that correlation risk is the biggest concern when creating portfolios. The higher the correlation, the greater may be the stock losses.
  2. The Canadian dollar’s dependence on oil and gas prices leads to greater currency volatility. If you earn only Canadian dollar income, whether or not it’s employment or pension income, you are exposed to Canadian dollar fluctuations.

For example, the Canadian dollar began its descent in 2014 from one dollar to the USD to today’s 77 cents on the back of declining oil prices. As a result, Canadians’ spending power relative to the rest of the world fell 23%. In other words, if food costs in 2014 were $1.00, they’re now $1.23.

That’s where foreign investments help offset the decline in spending power. If your investments are in other currencies and the Canadian dollar falls, those investments will be worth more, thereby creating a natural hedge to your spending power.

The bottom line is this: When the Canadian dollar is strong (at par), buy foreign investments. When the Canadian dollar is weak (as it was in 1995 during the Quebec Referendum at 60 cents), buy Canadian investments and wait for the cycle to turn.