BofA Securities’ Research Investment Committee (RIC) is recommending three strategies to pick winning stocks, and one of them is very novel.
The analysts, in a report this week, said they expect the strategies will succeed despite the current investing environment where investors are focused on expensive U.S. technology stocks and bond performance is dependent on Federal Reserve rate cuts that may be postponed.
The first strategy, purchase stocks that BofA analysts have buy ratings on that may soon have their industry classification changed, is one I’ve never come across before. The RIC team estimate that companies where business models have evolved to the point they will be reclassified have outperformed the S&P 500 by between two and four per cent for the three months after the change. The reason is that reclassification requires US$6-trillion in investment funds to rebalance their sector exposure.
The team identified four companies where reclassification is possible. They argue that First Solar Inc. could move from technology to industrials, Bunge Global SA could move from staples to materials, Teledyne Technologies Inc. is more industrial than technological, and PTC Inc. could make a similar shift from the technology to industrial category.
The second investment strategy mentioned is familiar to many experienced investors: find the companies that are set to be added to the S&P 500. These stocks receive a veritable ocean of new investment once added, as passive funds add them to their index-tracking portfolios. Active managers that are concerned about falling behind the benchmark also add positions. The next rebalancing announcement of the benchmark U.S. index will arrive the third Friday of March.
The RIC team identified 24 buy-rated companies that qualify for S&P 500 inclusion based on steady profitability and market capitalization.
These are KKR & Co. Inc., Workday Inc., Palantir Technologies Inc., Ares Management Corp., Tradeweb Markets Inc. Vertiv Holdings Co., Deckers Outdoor Corp., Booz Allen Hamilton Holding Corp., Royalty Pharma PLC, BioMarin Pharmaceutical Inc., Dynatrace Inc., Vistra Corp., Avantor Inc., Saia Inc., XPO lnc., Owens Corning, Neurocrine Biosciences Inc., Burlington Stores Inc., TopBuild Corp., AECOM, Renaissance Re Holdings Ltd., Floor & Decor Holdings Inc., Ovintiv Inc. and Rexford Industrial Realty Inc.
Identifying stocks set to split, strategy recommendation number three, is not easy but investors capable of doing so reap significant returns. The RIC report notes that stocks that split generate average returns of 25 per cent historically in the subsequent 12 months. Stock splits have generated positive returns in every decade since at least 1980, including the early 2000s when equity markets struggled.
The report argues that the most likely split candidates are stocks with prices in the 95th percentile, which is over US$500. The possible splits that are most identifiable to domestic investors include Chipotle Mexican Grill, Broadcom Inc., Blackrock Inc., WW Grainger Inc., Eli Lilly & Co., Costco Wholesale Corp., NVIDIA Corp., Adobe Inc., Netflix Inc., and Parker-Hannifin Corp.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Bird Construction Ltd. (BDT-T) This has been a holding of the Contra Guys for a few years now, and given the stock’s gains since that time - 77 per cent last year alone - they are cashing in some shares. But as writer Philip MacKellar of the newsletter tells us, the stock is still relatively cheap and the dividend is growing.
Stella-Jones Inc. (SJ-T) This Canadian company isn’t competing in the same sexy industry as Apple and BlackBerry, but it is a good company in the view of value investor professor Dr. George Athanassakos. Stella-Jones manufactures pressure-treated industrial lumber products, such as railway ties and utility poles. The company focuses on products that are tied to infrastructure and this insulates it from extreme volatility over the business cycle. But even though it has a competitive advantage and sustainability, he explains why investors should hold off buying shares for the time being.
The Rundown
Investors hope strong U.S. economy can insulate stocks from yield surge
As Treasury yields march higher again, some investors are betting a resilient U.S. economy and moderating inflation can shield stocks from their deleterious effects this time around. David Randall and Saqib Iqbal Ahmed of Reuters explain.
The U.S. became a global safe haven for stocks. So why do individual companies crash so easily?
Stock markets in the United States are thriving again this year, outshining indexes almost everywhere else around the world, yet there is a peculiar trend playing out for individual U.S.-listed companies: Their shares can plummet at the first sign of bad news. Tim Kiladze reports on what may be behind it.
Also see:
Nvidia outstrips Alphabet as third largest U.S. company by market value
Arm Holdings jumps over 40%, adds to staggering AI-powered rally
Three signs you’re holding onto a money-losing stock
As the stock market keeps rallying into the new year in many parts of the world, we have seen an increasingly challenging time for enterprising investors in two ways. First of all, higher valuations reduce prospective returns in general; secondly, it has become easier for stock pickers to fall into value traps. Portfolio managers Jason Del Vicario and Steven Chen have a checklist that will inform which stocks are worth holding and which ones aren’t.
U.S.-China world equity share a yawning chasm
Boosted by the latest wave of the seemingly never-ending rally in the “Magnificent 7″ group of leading tech giants, the U.S. share of global market cap is hitting historic highs just as China’s far smaller slice shrinks further, reports Jamie McGeever of Reuters.
Looming election puts battered British markets back in the spotlight
Britain’s economy might well have fallen into recession late last year, money has exited UK stocks and fears about unsustainable borrowing that have resurfaced ahead of a March 6 budget may stick until an election expected later this year. But the prospect of a change in government that lifts sentiment towards the economy has seen investors debating whether UK markets - including its equities - are too cheap.
Others (for subscribers)
Number Cruncher: Seven growing Canadian artificial intelligence stocks
Number Cruncher: 13 overlooked TSX stocks that combine growth and reasonable valuations
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Globe Advisor
RRSPs, TFSAs or FHSAs – where should Canadians invest when their money is limited?
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Ask Globe Investor
Question: I would like your opinion of the Hamilton Canadian Financials Yield Maximizer Exchange-Traded Fund (HMAX-T), which yields more than 15 per cent.
Answer: The Hamilton Canadian Financials Yield Maximizer ETF is a relatively new player on the high-yield scene, having been launched a little more than a year ago. It holds a basket of 10 of the largest Canadian financial institutions, primarily banks and insurers. All of these companies pay dividends, but their yields average just 4.3 per cent, which is less than one-third of the ETF’s 15-per-cent payout.
How does the fund bridge that yawning gap? Answer: It sells covered call options on stocks in its portfolio. A call option gives the buyer the right to purchase a stock at a specified “strike” price before a certain date. (It’s referred to as a covered call because the fund owns the securities on which the options are sold.)
Selling calls to earn “premium” income is common with high-yielding ETFs, but HMAX’s options strategy is more aggressive than most. For one thing, it sells – or writes – call options on about half of its portfolio, which is higher than many funds. For another, it focuses on writing at-the-money options, in which the strike price is at or near the market price of the stock, as opposed to out-of-the-money options, when the strike price is higher than the current market price.
Selling at-the-money calls generally brings in more premium income, because option buyers are willing to pay more given the higher probability that the option will be exercisable at a profit. The downside, however, is that there is a greater risk that the stock will be called away, which limits the ETF’s potential gains in a rising market.
HMAX’s returns bear this out. From the ETF’s inception on Jan. 20, 2023, through Jan. 31, 2024, it posted a total return, including dividends, of negative 0.32 per cent on an annualized basis. In other words, while HMAX was pumping out a fat monthly dividend, the income was more than offset by a falling unit price.
Compare that to the iShares S&P/TSX Capped Financials Index ETF, which holds many of the same securities but does not use a covered-call strategy. XFN posted a total return of about 6.5 per cent over the same period.
Robert Wessel, managing partner of Hamilton ETFs, said HMAX’s underperformance can be explained, in part, by differences in the composition of the two ETFs. For example, HMAX was overweight banks during a sluggish period for these stocks. And certain companies that have performed well recently, such as Fairfax Financial Holdings Ltd. (FFH) and Brookfield Asset Management Ltd. (BAM), are included in XFN but excluded from HMAX because they do not have liquid options markets.
“I can say with great confidence, the impact of the options strategy was significantly less than the 6-percentage-point difference in returns cited,” Mr. Wessel said.
Covered call writing may work well in flat or falling markets, but in general it does more harm than good, critics say.
“I consider the … strategy to be a gimmick to snare the unwary,” James Hymas, president of Hymas Investment Management Inc., said in an e-mail. “I have never seen any evidence whatsoever that any single one of these covered call enthusiasts are any good at writing and trading options. And if you’re not good at it you will give up more in foregone capital gains than you gain in option premia.”
What’s more, HMAX’s current monthly distribution of about 17.5 cents is not guaranteed. As the company says on its website: “Hamilton ETFs may, in its complete discretion, change the frequency or expected amount of these distributions.”
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
What’s up in the days ahead
Tim Shufelt will explain why there is such a sharp gap in performance between the U.S. and Canadian stock markets.
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff