The Top 200 Canadian Stocks for 2016
There's something magical about the first snowfall of the season, when snowflakes meander down from the sky to cover the remnants of autumn in a white blanket. If you pause and take a close look at each flake, a world of beautiful crystals opens up. They come in all sorts of shapes and sizes, which makes it hard to pick a favourite.
In a similar way, it can be difficult to sort through the stock market to find the best prospects. That's why we're here to offer a helping hand with the 12th annual MoneySense All-Star guide to the Top 200 Canadian stocks. It's packed full of just the sort of information investors crave and it includes an easy-to-use grading system.
We're pleased to say our approach has weathered both good times and bad over the past 11 years. Our All-Star Stocks, which combine the best growth and value prospects, gained 15.8% per year on average since we started in 2004. That assumes an equal dollar amount was put into each All- Star Stock in the first year and rolled into the new All-Stars each year thereafter. By way of comparison, the S&P/TSX Composite (as represented by the XIC exchangetraded fund) climbed 4.4% per year over the same period.
In other words, the All-Star Stocks beat the market by an average of 11.4 percentage points per year.
If you had split $100,000 equally among the original All-Stars 11 years ago and moved into the new stocks each year, your portfolio would now be worth more than five times your original investment. Those who invested in the index would have turned their $100,000 into just $161,000. Better yet, we're also happy to report that last year was another positive one for the All-Star list, which gained 2.1% since our last update. It bested the S&P/TSX Composite exchange-traded fund by 5.3 percentage points over the same period. (Please note that all the return figures mentioned above do not include dividends.)
But we hasten to add that our brilliant overall gains came with a few frosty periods along the way. For instance, the market suffered from a crash of historic proportions in 2008 that saw the All-Stars fall almost 33% since the prior November. In addition, the All-Stars trailed the market in three of the last 11 annual periods.
While we'd love to be able to say that cold snaps are a thing of the past, seasoned investors know that every stock-picking method suffers from chills. We fully expect the All-Stars to lag the market, or even lose money, on occasion. In addition, some individual stocks will inevitably shatter. While we do our best to avoid such situations, investors can't enjoy the market's sunny periods without suffering from a frosty nip now and then.
The Top 200 focuses on Canada's largest 200 companies (by revenue) using data from Bloomberg. Each firm is evaluated in two fundamentally different ways. First we consider a stock's attractiveness as a value investment and then we determine its appeal as a growth investment.
Our value and growth tests employ a bevy of detailed calculations that are strictly based on the numbers. Our feelings or intuitions about a company don't enter into it. At the end of the day, we sum up everything about a stock in easy-to-understand grades: one for value and the other for growth.
The grades work just like they did when you were in school. The top of the class get As, solid firms are awarded Bs or Cs, and those that are lacking get Ds or even Fs. Stocks with good grades are deemed worthy of consideration while those at the bottom of the class should be treated with caution. The select group of stocks that get at least one A and one B on the value and growth tests make it into the All-Star list. But, before we discuss this year's top stocks, let's take a closer look at how the grades are calculated.
Value investors are bargain hunters who like solid stocks selling at low prices. That's why we prefer companies with a low price-tobook- value ratio (P/B). This ratio compares a firm's market value to the amount of money that could be theoretically raised by selling off its assets (at their balance-sheet values) and paying off its debts. A low P/B ratio provides some assurance you're not paying much more for a company than its parts are probably worth - and to get top marks for value, a stock must have a low P/B ratio compared to the market and also compared to its peers within the same industry.
We also track price-to-tangible-bookvalue ratios. Tangible book value is like regular book value, but it ignores intangible assets like goodwill. It's a more rigorous test of how much a company would be worth if it had to be sold for scrap.
Assets are one thing, but it's also important to examine a company's bottom line. We prefer profitable companies and award higher grades to firms with a positive price-to-earnings ratio (P/E) based on their earnings over the past 12 months. We also reward a company when analysts expect it to be profitable and have a positive P/E over the next year. (This number is known as the forward P/E ratio.)
Because we know investors like to rub more than a couple of pennies together, we award extra marks to firms that pay dividends. As it happens, dividend-payers generally outperform miserly firms that don't pay dividends. For safety's sake we also want to make sure a company hasn't loaded up on debt. That's why we award better grades to firms with low leverage ratios (defined as the ratio of assets to stockholders' equity), relative to their peers. All of these factors are layered into a single value grade. Only 20 out of 200 stocks got an A this time around.
Grading for growth
It should come as no surprise that growth investors love firms with increasing sales and earnings. That's why we award higher marks to companies that have achieved reasonable sales-per-share (SPS) and earningsper- share (EPS) growth over the last three years. We also track each firm's growth in total assets over the last year to get a sense of the momentum in its business.
While fundamental growth is great, we like it when the market takes notice. That's why we give higher marks to stocks with solid returns over the past year.
In addition, we want to make sure that companies use their capital wisely. To do so we track each stock's return on equity, which measures how much a firm is earning compared to the amount shareholders have invested. Return on equity is a measure of business quality and we give higher marks to those firms that outperform their peers.
Since no one wants to skate out onto thin ice, we weigh up each stock's price-to-sales ratio, which as you might expect, compares its price to its sales. We figure stocks with low-to-moderate ratios are reasonably priced while those with extreme ratios run the risk of collapsing.
We put all these factors together to determine each stock's growth grade. Only 20 out of the 200 got an A this year.
Three firms got top marks this year by earning both an A for value and for growth. The double-A prize went to Power Corp of Canada (POW) and its subsidiary Power Financial (PWF). They're both based in Montreal and have interests in insurance, money management and other businesses. Fortis (FTS) also got double As. It's an electric and gas utility based in St. John's, Nfld., that has customers in Canada, the U.S. and the Caribbean.
The remaining eight All-Stars earned one A and one B on our value and growth tests. They include insurance-based conglomerates Fairfax Financial (FFH) and E-L Financial (ELF). (Disclosure: I own shares of both.) They're accompanied by homeimprovement chain Rona (RON) and homefurnishing retailer Leon's Furniture (LNF). In addition, auto parts companies Linamar (LNR) and Magna International (MG) made the grade. Finally, engineering firm WSP Global (WSP) and steel-component maker Canam Group (CAM) round out the list.
Before skating off to buy any stock, do your own due diligence and make sure its situation hasn't changed in any important way. Read the latest press releases and regulatory filings, scan newspaper stories and get up to speed on all the recent developments. (Take particular care buying or selling stocks that trade infrequently.) If you do, you'll be in a better position to weather the market's changing seasons.
+ Download the Top 200 (.xls file)
First published in the December 2015 edition of MoneySense magazine.
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