This April 1st, don’t pull a prank on your portfolio with these silly stocks.
we’d help you spot stocks that could end up pranking your portfolio. Using Morningstar® CPMS™, I came up with a list of Canadian-listed companies that investors should think twice about before buying. Though I wouldn’t necessarily call owners of these companies ‘fools’ per se, experienced investors would be remiss if they didn’t consider some of the deteriorating fundamental characteristics of the below list of stocks.
The Dangerous Strategy
For over three decades, Morningstar® CPMS™ has tracked a portfolio of “Dangerous” stocks, or those that fundamentally appear overvalued, over leveraged, and exhibiting shrinking reported earnings. For the record, the performance of the Dangerous strategy looks like this:
In the spirit of the day, I thought to highlight the factors that go into ranking stocks within this strategy. The strategy ranks stocks on a few core factors including:
Readers will quickly question the rank order of the factors as they are counterintuitive for a long investor. For example, investors typically look for companies with growing earnings momentum (not shrinking), and positive estimate revisions from the street (not negative). In essence, the strategy looks for companies that have a combination of generally undesirable characteristics. Based on the long-term performance of the strategy, it seems to have worked as intended, producing a since inception annualized return of -9.2% (ouch!) where the S&P/TSX Composite TR index produced an annualized 8.5% over the same time period. Today, the list of qualifiers to purchase (read: probably avoid) into the dangerous model include:
Are All of These Bad?
No, not necessarily. The strategy’s rules call for it to consistently pick stocks with the above characteristics. Over time, the strategy has performed as expected – very poorly. However, the chart shows that there were periods where Dangerous stocks did really well. For example, we can see that holding Dangerous stocks during the technology bubble of 2000-2002 would have afforded an investor exuberant returns during the rally, and Icarus-like results during the crash. Similarly, we’ve observed that after major market corrections, stocks that make the ‘dangerous’ list tend to exceptionally well, provided that they don’t go bankrupt during the correction itself. All this said, for the conservative investor who looks for more reasonable returns consistently over time, you probably won’t find those on this list.
With Canada’s inflation at a 30-year high, the Bank of Canada is under pressure to take steps to bring it under control. One of the key levers in a central bank’s inflation-management toolkit is interest rate manipulation. The BoC has hinted it will soon start raising the overnight interest rate from record lows – it currently sits at 0.25% — to combat inflation.
Rising interest rates push up the cost of borrowing, a concerning development for consumers and borrowers. However, rate hikes create a tailwind for financial institutions by improving profitability and a stable economic environment for the broader financial sector, one of the strongest pillars of the nation’s economy.
Canadian investors looking to readjust their portfolios to align with the higher interest rate environment may want local lenders to buttress their portfolios. Leading Canadian financial institutions enjoy oligopolistic control of banking deposits, which keeps them highly profitable during periods of economic strength and resilient during downturns.
One of Canada’s two largest banks, Toronto-Dominion (TD) operates three business segments: Canadian retail banking, U.S. retail banking, and wholesale banking. The bank has a strong U.S. presence where it also owns 42% stake in TD Ameritrade, a discount brokerage. The bank derives approximately 55% of its revenue from Canada and 35% from the U.S., with the rest from other countries.
“Toronto-Dominion has done an admirable job of focusing on its Canadian retail operations and growing into number-one or -two market share for most key products in this segment,” says a Morningstar equity report.
The bank also boasts a number-two market share for business banking in Canada. With over $400 billion in Canadian assets under management and the largest card issuer in Canada, “Toronto-Dominion should remain one of the dominant Canadian banks for years to come,” the report adds.
The Canadian lending heavyweight has a significant presence in the U.S. with more branches stateside than any other Canadian bank.
TD’s dominant position in the discount brokerage space bodes well for its growth since “this industry is ripe for growth as investors seek out lower-cost alternatives, and the bank could leverage its knowledge of the industry for future growth in Canada,” says Morningstar equity analyst Eric Compton to recently raise the stock’s fair value from $85 to $97, prompted by strong quarterly results.
The bank’s wide economic moat is underpinned by its solid funding base, leading home market share, moaty nonbank businesses, and the favourable Canadian banking environment.
Bank of Nova Scotia (BNS) is the third-largest Canadian-based bank by assets and one of six Canadian banks that collectively hold almost 90% of the nation’s banking deposits. The global financial services provider has five business segments: Canadian banking, international banking, global wealth management, global banking and markets, and other.
The bank’s international operations span numerous countries with greater concentration in Central and South America. “It is known as Canada’s most international bank as it derives a little over half of its revenue from Canada, over 40% from international operations (primarily Latin America), and a single-digit percentage from the U.S.,” says a Morningstar equity report.
The lender’s domestic operations are more concentrated in mortgages and auto lending, with a leading market share in autos. Scotiabank has been expanding its domestic wealth operations significantly. Its acquisitions of MD Financial and Jarislowsky Fraser made it the third-largest active manager in Canada.
The bank has been rejigging its LatAm footprint. It has made strategic acquisitions in markets like Chile and Colombia while lowering exposure to businesses and geographies that are less favourable. “The international exposure gives the bank the potential for higher growth and return opportunities compared with peers, but it also exposes the bank to more risks, as we’ve seen during the pandemic,” says Compton, who recently raised the stock’s fair value from $83 to $87, after incorporating the latest quarterly results.
The bank’s digital efforts are reflected by spending on technology and communication. “These efforts will ultimately pay off in the form of improved operating efficiency, customer engagement, and internal sales coordination,” says Compton.
One of the two largest Canadian lenders by assets, Royal Bank of Canada (RY) generates two-thirds of its revenue from Canada, with the rest spread primarily across the U.S. and the Caribbean. Its diverse services include personal and commercial banking, wealth management services, insurance, corporate banking, and capital markets services.
Royal Bank has done a commendable job expanding its nonbank lines of business, running efficient banking operations, and generating some of the best returns for shareholders in the industry. “RBC should remain one of the dominant Canadian banks for years to come, even as a more difficult macro backdrop pressures earnings growth in the medium term,” says a Morningstar equity report.
Royal Bank of Canada has the largest amount of assets under management among the Canadian banks and is projected to remain a formidable player in its domestic retail and commercial banking operations.
It is also expected to maintain its dominance in global capital markets, a segment that is expected “to continue to be a strong contributor to net income,” the report adds, pointing out that “if anything, capital markets have been countercyclical for the bank during the pandemic as earnings have soared for the unit.”
The wide-moat bank’s wealth-management segment also boasts strong returns on equity with large inflows lifting it to a top market position. “RBC remains a top asset manager and gatherer in Canada and is also experiencing outsize growth from [U.S banker] City National, where cross-selling and client integration efforts have gone well,” says Compton, who recently upped the stock’s fair value from $132 to $141.
Loblaw Companies Ltd.’s fourth-quarter results beat analysts’ expectations on Thursday as the Canadian retailer was boosted by its pharmacy business and a continued demand for groceries.
The company says it earned a profit available to common shareholders of $529 million. Its fourth-quarter revenue rose about 10 per cent to $14.01 billion from the same period last year, topping estimates of $13.75 billion.
On an adjusted basis, Loblaw earned $1.76 per share, beating analysts’ expectations of $1.71 per share.
Chief financial officer Richard Dufresne said during a Thursday morning earnings call that the company’s gross margins in food retail had peaked in mid-2021, before Canada’s current inflation episode began, but hadn’t returned to those levels since.
He then said that the earnings results “are further evidence that [food] retail prices are not growing faster than costs, and the company is not taking advantage of inflation to drive profits.”
Australian mining giant BHP is optimistic China and India’s growth will boost commodity demand, even as the company reported a steep drop in half-year profits.
“We believe that Chinese growth and Indian growth are going to provide a bit of a counterbalance and support overall growth over the next six to 12 months, and beyond,” CEO Mike Henry said.
Canada’s decision to enter formal bilateral trade talks with Taiwan is part of a broader strategy for the Indo-Pacific region, the country’s minister of international trade told CNBC Tuesday.
The two sides agreed on Feb. 7 to begin formal negotiations on a trade agreement in order to strengthen trade and investment.
“I was able to launch what we call FIPA — it’s a foreign investment, protection arrangement with Taiwan, but it is very much a part of Canada’s Indo-Pacific strategy for diversification into the region,′ Mary Ng, the trade minister told CNBC’s “Squawk Box Asia” on Tuesday.
The Canadian dollar CADUSD -0.52%decrease weakened against its U.S. counterpart on Tuesday as investors dialed back bets on additional interest rate hikes by the Bank of Canada following softer-than-expected domestic inflation data.
Canada’s annual inflation rate eased to an annual rate of 5.9 per cent in January from 6.3 per cent in December, Statistics Canada data showed. Analysts had expected inflation to slow to 6.1 per cent.
Money markets now see a roughly 80 per cent chance that the BoC will raise interest rates again this year after having fully discounted such a move before the data.
Last month, the central bank signaled a pause in its tightening campaign after raising its benchmark rate to a 15-year high of 4.50 per cent.
The Canadian dollar was trading 0.4 per cent lower at 1.35 to the greenback, or 74.07 U.S. cents, after moving in a range of 1.3442 to 1.3507. On Friday, the currency touched a six-week intraday low at 1.3537.
The loonie fell as equity markets globally slumped and the U.S. dollar gained ground against a basket of major currencies.
The price of oil, one of Canada’s major exports, was up 0.8 per cent at $76.97 a barrel.
Canadian government bond yields were higher across the curve, tracking the move in U.S. Treasuries and German Bunds following stronger-than-expected business activity data in the euro zone.
The 10-year touched its highest level since Nov. 10 at 3.400 per cent before dipping to 3.374 per cent, up 8 basis points on the day.
Borrowers are expected to prop up Canada’s biggest banks’ financial results for the first quarterof the fiscal year, even as the threat of a recession weighs on lenders’bottom lines.
Analysts anticipate that loan growth will boost results, fuelled by aggressive interest-rate hikes by the Bank of Canada and demand from commercial customers. But analysts are also watching for slowing growth in mortgages – which make up a swath of the banks’ overall lending portfolios – and rising reserves for potential sour loans, all while tighter regulatory and government oversight take a notch out of earnings.
On Feb. 24, Canadian Imperial Bank of Commerce CM-T -1.10%decrease will be the first major bank to report earnings for the fiscal first quarter, which ended Jan. 31. Bank of Montreal BMO-T -1.07%decrease and Bank of Nova Scotia BNS-T -1.06%decrease will release results on Feb. 28, followed by Royal Bank of Canada RY-T -0.34%decrease and National Bank of Canada NA-T -0.61%decrease the next day. Toronto-Dominion Bank TD-T -0.88%decrease will be the final Big Six lender to release earnings, on March 2.
On average, profits across the Big Six banks could rise 6 per cent from the previous quarter, but drop 8 per cent from the same period a year earlier, as loan loss provisions climb back up toward prepandemic levels, according to research by Keefe, Bruyette & Woods analyst Mike Rizvanovic.
Banks are expected to raise their reserve funds for bad loans – known as provisions for credit losses, or PCLs – in anticipation of a potential economic downturn. They had previously lowered the amount of money set aside for this purpose, after the pandemic produced fewer loan defaults than expected.
But even as loan losses edge up from their pandemic trough, analysts expect the banks to make relatively minor adjustments to PCLs, because the downturn is expected to be mild.
“While we don’t dismiss the potential downside risk to earnings from rising PCLs as the economy weakens in a higher rate environment, we view a moderate recession (the current consensus view) as very manageable from a loan loss perspective,” Mr. Rizvanovic said in a note to clients.
Interest-rate hikes bode well for the banks’ net interest margins – the difference between the interest that banks pay on deposits and charge on loans. Banks can charge wider spreads and turn out bigger profits as central banks ratchet rates higher. With consumers continuing to reach for their credit cards and businesses opting for loans as employment remains strong, analysts expect loan books overall to continue to grow.
But higher rates also cause customer wallets to tighten, and demand for debt could shrink and squeeze margins. The greatest threat comes from the stunted mortgage market, as borrowing costs rise and fewer homebuyers qualify for loans.
“Fuelled by the BoC’s ongoing rate hiking cycle, we believe that the environment continues to be supportive for net interest margins,” Barclays analyst John Aiken said in a note. “Although Canada’s real estate market continues to moderate, we anticipate mortgage volumes will stay positive, albeit at a more modest growth rate. As such, we anticipate net interest income will continue to trend higher” from levels in the fourth quarter of the previous fiscal year.
The banks are also juggling new regulatory requirements that they carry more capital. In December, after most of the banks boosted dividends, the Office of the Superintendent of Financial Institutions (OSFI) increased the amount of money they must hold in case of an economic downturn, which is known as the domestic stability buffer. The OSFI also increased the potential range of the buffer – a cushion built up in good economic times to soften the blow if conditions worsen – opening the door for another hike in June.
This means that the banks could choose to avoid dividend increases, share buybacks and new deals, and instead build up their capital reserves.Toronto-Dominion Bank, Bank of Montreal and Royal Bank of Canada are already in the throes of some of the biggest acquisitions in the industry’s history.
The banks face rising capital thresholds at a time when the federal government has imposed higher taxes in the sector, with a permanent increase to the corporate income tax rate for banks and insurers, and a temporary tax called the Canada Recovery Dividend that will be imposed over five years.
While investors’ main focus will still be on key net interest margins this quarter, the spotlight will begin to shift to concerns about how banks will sustain higher capital levels, according to Scotiabank analyst Meny Grauman.
“A more challenging capital and regulatory environment for banks … is something that we are very concerned about,” he said in a note.
Even so, bank stocks have started the year on a tear. The S&P/TSX Composite Banks Index has climbed about 9 per cent this year, outperforming the S&P TSX Composite Index’s 6-per-cent gain. But this is partly a result of the market’s increasingly bullish tone, as central banks signal potential rate-hike pauses and predict a coming economic downturn they say will be less severe than others in recent decades.
As the market cautiously crawls out of last year’s slump, beleaguered wealth management and investment banking divisions that saw activity sink in 2022 could rebound, and benefit bank earnings in the year ahead.
“U.S. banks and some of the Canadian banks have indicated there is a robust pipeline of investment banking activity waiting for better market conditions,” CIBC analyst Paul Holden said in a note.
Canada’s annual inflation rate eased more than expected to 5.9 per cent in January, data showed on Tuesday, backing up the Bank of Canada’s declared aim to keep rates on hold at its next meeting to let previous rate hikes sink in.
Analysts had expected inflation to edge down to 6.1 per cent from 6.3 per cent in December. Month over month, the consumer price index rose 0.5 per cent, Statistics Canada said, again lower than analysts’ forecast of a 0.7 per cent gain after a 0.6 per cent decline in December.
Statscan said part of the easing of the annual rate was due to the comparison with last year’s strong inflation numbers, or because of a base effect. In January last year prices gained amid Russia-Ukraine tensions and supply chain disruptions.
“There were some very strong base effects from last January that are starting to roll out of the headline inflation metrics,” said Andrew Kelvin, chief Canada strategist at TD Securities.
The inflation figure “allows (the Bank of Canada) to stay on hold in March, despite the fact that the labour market was extraordinarily hot in the month of January,” he said.
The Bank of Canada in January raised its benchmark interest rate to a 15-year high of 4.5 per cent and became the first major central bank to say it would hold off on further increases as long as prices eased in line with its forecast.
But Canada’s economy then smashed expectations by adding a net 150,000 jobs in January, data showed earlier this month.
Markets toned down their bets on another rate hike after the release of the inflation figures. Money markets now see a roughly 80 per cent chance that the Bank of Canada will raise interest rates again this year after having fully discounted such a move before the data.
The bank forecasts inflation to slow to about 3 per cent by the middle of 2023, and to come down to its 2 per cent target next year.
Excluding food and energy, prices rose 4.9 per cent compared with a rise of 5.3 per cent in December.
The average of two of the central bank’s core measures of underlying inflation, CPI-median and CPI-trim, came in at 5.1 per cent compared with 5.3 per cent in December.
“It gives them (the Bank of Canada) somewhat greater comfort in their decision to go on pause at least temporarily,” said Doug Porter, chief economist at BMO Capital Markets. “A lowside inflation read will definitely prove to be a nice antidote to some of those high-side surprises.”
Adding to the favourable base effect, cellular services fell 7.9 per cent annually in January after increasing 2.5 per cent in December, and consumers paid 6.2 per cent more for passenger vehicles compared with 7.2 per cent in December.
Mortgage interest costs, on the other hand, rose 21.2 per cent annually in January, the largest increase since 1982, while food prices rose 10.4 per cent, slightly faster than the 10.1 per cent in December.
The Canadian dollar was trading 0.4 per cent lower at 1.35 per U.S. dollar, or 74.07 U.S. cents.
Cenovus Energy Inc CVE-T -2.07%decrease posted a net profit for the fourth quarter on Thursday, compared with a loss last year, and said Chief Operating Officer Jon McKenzie would become its president and chief executive officer.
McKenzie, who was the finance chief of Husky Energy from 2015 to 2018, joined Cenovus in 2018 as its chief financial officer.
Outgoing CEO Alex Pourbaix will shift to the role of executive chair after the company’s annual general meeting on April 26, where he will be nominated for election to the board.
Cenovus’s total revenue rose nearly 3 per cent to $14.1-billion in the fourth quarter, helped by an increase in downstream operating margins.
U.S. oil prices pulled back from a multiyear high in the quarter, but were trading 9 per cent higher than the year-ago level as Western sanctions against major energy producer Russia and a decision by OPEC+ to cut output tightened global supply.
The Calgary, Alberta-based company reported a profit of $784-million, or 39 cents, for the fourth quarter ended Dec. 31, compared with a loss of $408-million, or 21 cents per share, a year earlier.
Its total upstream production stood at 806,900 barrels of oil equivalent per day (boepd), down from 825,300 boepd a year earlier. Downstream production rose to 473,500 barrels per day (bpd) from 469,900 bpd last year.
