Searching for best stocks within North America

Ashley Redmond: I’m here with James, a portfolio manager at Caldwell Investment Management. He's a value manager and co-manages Caldwell Balanced Fund.

James, thanks so much for joining me.

James Telfser: Yeah, thanks for having me.

Redmond: So, your stock selection process is a bottoms-up approach. So, what criteria do you use when selecting stocks?

Telfser: First of all, our criteria starts a little bit different than the typical value manager, in that we look at the whole universe and we say, we're looking for the best ideas within North America. And from there we filter down, so we're not focused on a benchmark or anything like that as we do not have to hold stocks within certain sectors.

And then it's a value – it's a value-based approach, and that's where we start. We look for companies that are undervalued relative to their peers or the sector. We go on look at the balance sheet, which is something that's – which is key in a market environment like this, because you never know when a shock is going to come and you need companies that are going to be able to withstand that kind of shock, and that's the balance sheet. Look at the companies that have cut their dividends this year. It's because they had poor balance sheets and they couldn't sustain a downturn, and that causes capital depreciation on the stock.

And then next, we look at the management and then we look at the environment that we're into, make sure that we're not into sort of companies that are in a secular decline. Like think about PCs; we're looking for things that are actually going to increase. You don't want to get into any kind of value trap like you would with PCs or maybe with gold, for example. Those are some ideas of sectors that we couldn't get comfortable with.

Redmond: Okay. So, what stocks are you looking at right now? What are standing out?

Telfser: Well, in Canada particularly, first of all, we're looking more to the U.S. than in Canada, but we have about 45% of our weight in Canada, so we will focus on some names that we see there. And a lot of the names are different than what the typical Canadian manager would look for. For example, we don't hold any banks – we hold one – we just recently added a bank. But it's kind of interesting as a Canadian portfolio manager to not hold any of the big banks.

And, so, the first stock that I was going to talk about today is Onex. So, Onex is a private equity company, as you know in Canada, and they've been doing quite a good job over the last 25 years growing their net asset value through private investments. So, the great thing about a company like Onex is that they're diversified in sectors and they often invest in companies that you don't get a chance to invest in yourself as a public portfolio manager.

So, they're trading at around their net asset value, so it hits the value parameter. They've got a great balance sheet. They have no debt. And then the environment right now – well, the management team is, it's next to nobody, they've got a fantastic management team. And the environment itself is very attractive right now if you think about low interest rates. When are you going to buy companies or when can you monetize assets for a private equity company? It's right now when people can actually afford to take a big stake in some of the businesses they hold in their portfolio. So that's one stock that we like. That's a little bit different than the typical manager who may stick to some of the big banks.

Redmond: Okay. So, I was just at the Morningstar Investment Conference in Chicago, I was telling you earlier. And a lot of people are interested when they're looking at Canadian universe in sectors, because we have trouble with asset allocation here. So, what sectors are you finding value in right now in the Canadian marketplace?

Telfser: In the Canadian market, information technology, believe it or not, is somewhere we're finding a lot of great value. And we're not talking about Research in Motion. That's a stock that couldn't really pass our environment criteria. We weren't sure where that was going to go. But companies like CGI Group, which is a great Canadian story; they recently made an acquisition in Europe, Logica. And this is a transformational acquisition for them. It's going to be accretive to their earnings in the tune of 25% to 30%. And they're actually well ahead of their initial timeframe. So, if you believe in the story, which we do, and we believe in their management team, this is what they do. They buy companies, they integrate them to their model, and they've been way ahead of schedule on this with one of the biggest acquisitions they've ever made.

So, it's a great Canadian company. It's actually undervalued at the moment. It's trading at around 12 times earnings. We think they could trade at 14 times. So, as far as an information technology company in Canada, this is one of the ones that that we would definitely own.

And Celestica; I mean, Celestica is another great name that's had a really good run recently, and they do manufacturing of IT parts. So, this is another company that's undervalued. They generate a lot of cash, and we think that those two companies are great holdings in the Canadian equity portfolio.

Redmond: That's great. And I know you're obviously heavily diversified in the U.S. market as well. So what sector there is standing out in the U.S.?

Telfser: In the U.S. it's actually technology as well; technology and industrials. So, we're seeing a lot of value in the large-cap technology companies; your Ciscos, your Qualcomm; Oracle, which reports tomorrow, which we're paying a lot of attention to. So, these are companies that we're focusing on. They're very cheap. They're increasing their dividends. They've got a lot of cash on their balance sheet. And if we get an uptick in U.S. GDP or global GDP in the next year, maybe looking into 2014, they should do – should start to do very well. They've driven a lot of operating efficiencies through the downturn.

And it's the same story with the industrials. When you look at companies like FedEx or some of the rails in the U.S., which are – we think are much better valued than the rails in Canada, they're trading at discount multiples to their history, they've created a lot of operating efficiency in their business. And if we get an uptick in the U.S. economy, they should start to do extremely well.

Redmond: That's great. So, my last question for you James as co-manager of Caldwell Balanced Fund, what's your overall strategy, what's your overall approach, things you'd want investors to know that are watching?

Telfser: Yeah. Well, I think you'd want to know that we're concentrated. So, we don't take – we don't look at the whole market and say, we need to want to own a piece of everything. We just look for the best ideas in the global marketplace. And for us, we focus on North America. And if we find cheap stocks that hit all of our criteria that I mentioned; the value, the balance sheet, good management team, and they're in a solid environment, that's a stock that we want to own.

So, we don't try to manage ourselves through any kind of benchmark, which is really important in an environment like this, where the market is actually fairly valued. If you look at the valuation of the S&P 500 and the TSX, we're not in that cheap state anymore; we can just throw darts and buy any stock. So, stock picking is becoming increasingly important, and avoiding sectors that are going to underperform is becoming increasingly important.

So, pick your entry points in stocks that hit your criteria on the value side that are cheaper than the market and you should do well in the long term.

Redmond: Great. Thanks so much, James.

Telfser: My pleasure.

Redmond: For more information on stocks, go to the Stocks section of morningstar.ca.