Warren Buffett’s comments at this year’s Berkshire Hathaway annual meeting, recounted in a must-read November article in Fortune magazine, might constitute a watershed moment by changing the definition of what it means to be a valuation-conscious investor.
In discussing his largest investment, Apple Inc., Mr. Buffett said, “The four largest companies today by market value do not need any net tangible assets… They are not like AT&T, GM, or Exxon Mobil, requiring lots of capital to produce earnings. We have become an asset-light economy.” Mr. Buffett later admitted that not buying Google was a major investing mistake.
The article goes on to note that Mr. Buffett is no stranger to adapting investing methodology. He was initially an acolyte of the Benjamin Graham value investing style – don’t pay more for a stock than the value of its equipment could receive at liquidation. Mr. Buffett later evolved in the 1960s to a focus on companies with strong brand names (brands like Coca-Cola were made more powerful by the explosion in television advertising) and steady growth.
Corporate and market success in recent years has been driven by intellectual property, not expanding manufacturing capacity to sell more goods. Biotechnology stocks are arguably the best example of this, developing drug treatments that can be replicated at very little cost but still sold at high prices while patent protection limits competition.
Software companies are similar – developers spend thousands of hours designing products that can be copied for free and sold.
Generating successful products is difficult for biotechnology and software companies, but the costs of making the resulting physical goods is non-existent relative to old economy industrials like General Motors.
The end result is that profit margins for intellectual property-based companies are extremely high. The average gross margin for companies in the S&P Biotech index, for instance, is 83 per cent. For the S&P Automobiles index, it’s 14.4 per cent.
These high profit margins lead to expensive valuation levels in terms of price to earnings and other metrics. Up until now, value investors have largely ignored new economy stocks because of valuation but Mr. Buffett’s foray into Apple provides a signal that the tide is changing, along with the whole idea of value investing.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Tricon Capital Group Inc. (TCN-T). Investors looking to bet on the U.S. housing market are sizing up Tricon Capital Group Inc., a Toronto-based, U.S. Sunbelt-focused stock that analysts believe is undervalued. Shares of TSX-listed Tricon, an investor and asset manager in the North American residential real estate industry, have fallen 13.6 per cent over the past year, further than the S&P/TSX Composite Index’s drop of 8.8 per cent over the same period. “It’s been a tough year for the equity, and therein lies the opportunity,” Raymond James analyst Ken Avalos said in an interview. He has a $13 price target on the stock and a “buy” recommendation. Brenda Bouw reports (for subscribers).
The Rundown
Desjardins Securities reveals its top stock picks for 2019
Heading into 2019, the equity research team at Desjardins Securities recommends investors “remain steadfast in looking for the best-positioned names” in order to battle through the current market volatility. In a research report released Tuesday, the analysts revealed their top 28 stock picks for the coming calendar year spread across eight sectors. Their selections for 2018 provided an equal-weighted average total return of negative 2.2 per cent, exceeding both the negative 12.6-per-cent performance for its entire coverage universe and the 6.2-per-cent dip for the S&P/TSX Composite Index. David Leeder reports (for subscribers).
Ahead of U.S. rate decision, Trump has set up Fed for failure
Donald Trump may be no scholar of economics, but he is a genius at spotting a good scapegoat. On Monday, the U.S. President tweeted his outrage at the thought of the Federal Reserve raising interest rates at its meeting this week. “It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike,” he wrote. “Take the Victory!” Mr. Trump’s unsolicited advice is the last thing Fed chairman Jerome Powell needs at this point. He is already facing an army of worriers as he attempts to fine-tune interest rates against a backdrop of tumbling stocks and a slowing global economy. Now, he is in an even tougher position: If he decides to refrain from raising rates on Wednesday, he will be seen as caving in to political pressure – exactly the opposite of what the Fed was designed to do. However, if he goes ahead and bumps rates marginally higher, as the market expects, he will be blamed by Mr. Trump and his base for anything bad that follows. Ian McGugan reports (for subscribers).
Inflation fears are overblown: The Fed should pause in 2019
Since the great financial crisis, markets have been intensely influenced by the words of central bankers, and that’s no different this week, as the U.S. Federal Reserve makes its next interest rate policy announcement on Wednesday. It’s widely expected that the Fed will hike rates for the ninth time since 2015, moving the target rate closer to neutral territory. What the Fed decides to do this week isn’t the key, instead I’ll be paying close attention to the words spoken by Fed chair Jerome Powell, as the timing of future rate increases will be vitally important to the outlook for the U.S. economy as well as global stock markets. Continued hiking in the first half of 2019 to or above neutral would be a misread, and stocks would continue to struggle. Marija Majdoub from MD Financial Management explains.
'Ready to pounce’: Where an outperforming small-cap fund manager is seeing opportunities as markets tumble
The market downturn has unearthed a number of buying opportunities for investors, but portfolio manager Teresa Lee warns the window may be short. “Having a portfolio that’s down is challenging, but it’s actually quite pleasant to be analyzing businesses in this kind of environment because you have interesting businesses trading at very attractive valuations in some cases. You’re actually able to able to buy names where the perceived risk is overblown,” says Ms. Lee, co-chief investment officer at Toronto-based Sionna Investment Managers, which manages $5-billion in assets. Brenda Bouw interviewed Ms. Lee to find out what stocks she is buying and selling (for subscribers).
Gordon Pape: Here’s how my predictions turned out in a bizarre, unnerving year for investors
We’re into the final weeks of 2018 and the end can’t come soon enough for most investors. It’s been a strange and unnerving 12 months, filled with plot twists worthy of a Shakespearean tragedy. Back in early January, who would have believed that Canada would be deemed a strategic risk to the U.S. and have tariffs slapped on our steel and aluminum exports? Who would have thought that the controversy over the Trans-Mountain pipeline would end up with Ottawa buying the embattled project? Who foresaw Canadian oil prices falling to record lows, deepening the recession in Alberta? How could we have predicted the economic and political fallout that we’re now experiencing after the arrest of a Chinese business executive in Vancouver at the request of the U.S.? And the list goes on and on. It has truly been a bizarre year! Unhappily, 2019 isn’t looking a lot better. So, given all the turmoil, what happened with the predictions Gordon Pape made back in January, in the first issue of the year? Let’s take a look at his forecasts (for subscribers).
How aggravated clients can reconnect with their advisers
The recent stock market uproar presents an ideal opportunity to fix a client-adviser relationship gone sour. Call your investment adviser to discuss why you’re unhappy. Tell your adviser what’s on your mind as a client and give them a chance to respond. Lawyer Ellen Bessner figures that bad communication is the root cause of 90 per cent of the adviser-client disputes she’s been involved in over her career. That’s why she wrote a new book for advisers called Communication Risk: How to Bridge the Client-Adviser Gap to Protect and Grow Your Business. At the back of the book is a guide to help investors get the most from their advisers. Rob Carrick takes a look (for subscribers).
Hedge fund moves at short end of U.S. curve show Fed cuts not too far away: McGeever
The Federal Reserve will raise interest rates later this week and probably again early next year, but that will be the end of tightening cycle and it won’t be long before rate cuts are on the table. That’s the message being sent out by the latest twists to hedge fund positioning at the short end of the U.S. Treasury curve: speculators now hold a record short position in two-year futures, while bullish momentum in five-year bonds is the strongest in over a decade.
Recent market ‘jolt’ will be first of many as easy money era ends, says BIS
Recent sharp selloffs across global financial markets are probably the first of many, as investors adjust to a world of tighter monetary conditions and the threat of economic downturn, the Bank of International Settlements said on Sunday. The year has been a tough one, with big drops in European and Asian stocks and even U.S. equities recently slipping into the red for 2018 after a decade-long bull-run. The last quarter saw increasing fears for world and U.S. economic growth as trade war noise escalated and central banks tightened policy or prepared to withdraw extraordinary crisis-era stimulus. The “market tensions we saw during this quarter were not an isolated event,” Claudio Borio, head of the monetary and economic department at the BIS said.
Others (for subscribers)
These 12 defensive TSX stocks combine value and quality
Money managers scared, but not bearish enough to trigger contrarian buy signal
Top U.S. fund managers prepare for bear market in small company stocks
‘Where are we in the Canadian housing slowdown?’
Monday’s analyst upgrades and downgrades
Monday’s Insider Report: Two high-yielding stocks that insiders are buying on price weakness
Tuesday’s analyst upgrades and downgrades
Tuesday’s Insider Report: Senior VP unloads over $8-million worth of this well-known large-cap stock
The Globe’s stars and dogs for last week
Others (for everyone)
DoubleLine’s Gundlach says U.S. equities are in long-term bear market
Ask Globe Investor
Question: I’ve read not to buy mutual funds before year-end to avoid paying tax on capital gain distributions. Does the same caution apply to buying real estate investment trusts (REITs) in December?
Answer: No. The problem with mutual funds is that many make only one capital gains distribution per year, in December. That amount can sometimes be significant and the tax implications costly.
For example, suppose you buy 100 units of a fund for $10 each in early December. The company then announces a capital gains distribution of $2 per unit two weeks later. You receive the distribution, but the net asset value (NAV) of your unit drops by the same amount to $8. You still have $1,000 in assets, but now it is divided between $200 cash and $800 in fund units. And the $200 distribution is taxable if received in a non-registered plan.
REITs make payments monthly, so the cash flow is spread out evenly over a full year. This is a very different scenario from mutual funds, so the same caution does not apply.
--Gordon Pape
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What’s up in the days ahead
David Berman looks at the investment case for Brookfield Property Partners, a stock now yielding a very juicy 7.9%.
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Compiled by Gillian Livingston