What are we looking for?
Favourably valued stocks linked to commodities that can provide portfolio diversification.
The screen
U.S. Federal Reserve Chair Jerome Powell recently testified to Congress and suggested that rate cuts in the near term remain a pipe dream. On the contrary, he stated that interest rates are “likely to be higher than previously anticipated.” Traditional asset classes such as cash, bonds and stocks tend to perform poorly during periods of high inflation and rising interest rates, and investors should prepare for more headwinds as economic conditions remains bearish.
Certain alternative asset classes, such as commodities, have historically performed well during inflationary periods and may offer savvy investors an opportunity to diversify their portfolios. While commodity futures, derivatives and specialized funds may offer more direct exposure to the asset class, they can often be inaccessible to retail investors because of knowledge constraints or requisite accredited investor status. As an alternative, investors can invest in equities with profits directly linked to commodity prices, providing some of the same diversification benefits.
We began identifying these equities by using FactSet’s Universal Screening tool to pull every security listed on a Canadian exchange. We further narrowed down our list using the parameters below:
- Classified within the energy or nonenergy materials sectors, according to FactSet.
- Market capitalization greater than $1-billion.
- Pays a dividend.
- Earned a positive net income in the past 12 months.
We ranked the 50 remaining companies (top 10 displayed) by a multifactor ranking of price to earnings; enterprise value to earnings before interest, taxes, depreciation and amortization; net debt to EBITDA; and dividend yield. These ratios provide a blended view of solvency, profitability and shareholder yield that are relevant to the commodity producer space.
More about factset
FactSet is a global financial data and technology company. FactSet’s suite of content, analytics and workflow services covers the entire portfolio life cycle and offers insights for asset managers and investment professionals around the world.
What we found
Stelco Holdings Inc. STLC-T, a steel producer, ranked No. 2 on our screen with promising valuation metrics. Steel prices have surged in 2023, rising 41.8 per cent year-to-date, which may account for Stelco’s phenomenal 27.6-per-cent year-to-date return. While steel prices have risen substantially, chief executive officer Alan Kestenbaum indicated in Stelco’s most recent earnings call that it will take some time for these prices to be fully realized as profits owing to varying costs of production. This could suggest further tailwinds to come for Stelco in 2023.
West Fraser Timber Co. WFG-T, a wood manufacturer, ranked No. 10 on our screen and can provide investors exposure to a less widely held commodity – lumber. Lumber prices surged over 30 per cent to start the year before falling sharply, now trading at close to flat year-to-date, providing a prime example of volatile price fluctuations often associated with commodities. West Fraser Timber’s stock price has closely followed the price of lumber this year, providing a meagre 1.2-per-cent year-to-date total return. As Canada’s largest lumber producer by capacity, it may be able to weather fluctuating lumber prices more effectively than its smaller contemporaries.
Lastly, investors looking to add exposure to energy will find six energy companies that ranked within our top 10. It should be noted that energy makes up a large portion of the Canadian equity market and investors may already have high exposure through conventional exchange-traded funds and mutual funds.
The information in this article is not investment advice. FactSet assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained above.
Arjun Deiva, CFA, is a vice-president at FactSet Canada’s consulting division.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.