Cheap Canadian Sector Stocks

Here are names that are under valued relative to sector peers  

Ian Tam, CFA 7 April, 2021 | 1:39AM

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Today, we look at a few core valuation metrics for Canadian-listed companies to find companies that that are under-valued relative to sector peers. Value-oriented investors have a few tools at their disposal when seeking investments:

  1. Price multiples of a stock against its own history: For example, if a stock is trading at 15.0x earnings today, and it was trading at 20.0x earnings a year ago, one might conclude that it is undervalued when compared to a year ago.
  2. Fair value estimate: Fair value estimates are typically derived by projecting out a company’s cashflows into the future and then applying a discount rate to determine the present value of those cashflows. The result is an estimation of what an analyst believes a company is worth today. Morningstar’s equity analysts take this one step further by comparing our own estimate to the current price of the stock and assigning stars to those that are trading below their fair value. A five-star stock is trading well below it’s fair value while a one-star stock would be considered over-valued based on our estimates.
  3. Price multiples of a stock against others in the sector: An investor might compare a stock’s price multiples against stocks that belong in the same sector or industry. The idea here is that if the companies in the same sector are slated to move in a similar direction over the long term, it might make sense to invest in those that are ‘cheaper’ or undervalued relative to their peers.

To illustrate the 3rd approach, I’ve used Morningstar® CPMS™ to screen companies in the S&P/TSX Composite Index on four key valuation metrics: price to forward earnings, price to cash flow, price to sales, and price to book. Moreover, I look for companies that are trading below the median of the sector to which they belong. For example, in the table below, a sector-relative price to earnings ratio of 0.7x would imply that the stock’s P/E ratio is 30% lower than that of the sector. To qualify, at least one of the four aforementioned ratios must be less than the sector.

Tohelp avoid the ‘value trap’ (when companies appear undervalued, continue to perform poorly, then appear even more undervalued), I also ranked stocks in the S&P/TSX Composite index on two core quality metrics: the stability of earnings and the return on equity (both measured over the last five years). The stocks that appear in the below table are sorted by sector, then by these profitability metrics. A maximum of five stocks were include per each economic sector.

The companies that meet these requirements today are listed in the following table:

Company Sector Sector Relative P/Sales Ratio Sector Relative P/E Ratio Sector Relative P/Book Ratio Sector Relative P/Cashflow Ratio
Labrador Iron Ore Basic Materials 4.0 0.6 3.0 1.6
Kirkland Lake Gold Ltd Basic Materials 1.2 0.7 1.1 0.9
Stella-Jones Inc. Basic Materials 0.5 1.1 1.6 1.4
Quebecor Inc., B Communication Services 0.9 0.8 2.7 0.9
Cogeco Communications Communication Services 1.1 0.8 0.8 0.9
TELUS Corporation Communication Services 0.9 1.3 0.9 1.1
Corus Entertainment, B Communication Services 0.4 0.4 0.4 0.6
Intertape Polymer Grp Consumer Cyclical 0.5 0.6 1.2 0.5
Winpak Ltd. Consumer Cyclical 1.3 1.0 0.5 0.9
CCL Industries Inc., B Consumer Cyclical 1.2 1.0 1.0 0.9
Sleep Country Canada Consumer Cyclical 0.7 0.7 0.8 0.5
Richelieu Hardware Ltd. Consumer Cyclical 1.0 1.2 1.1 1.2
Aliment'n Couche-Tard Consumer Defensive 0.9 0.8 1.1 0.8
North West Company Inc. Consumer Defensive 0.8 0.7 1.4 0.7
TC Energy Corporation Energy 1.8 0.8 1.2 0.9
iA Financial Corp Financial Services 0.1 0.8 0.8 0.4
goeasy Ltd. Financial Services 1.0 1.3 3.1 0.6
Equitable Group Inc. Financial Services 0.6 0.8 0.9 1.0
Sagen MI Canada Inc. Financial Services 1.8 0.8 0.7 1.1
Intact Financial Corp. Financial Services 0.6 1.5 1.4 1.4
Transcontinental Inc. Industrials 0.3 0.4 0.4 0.3
Westshore Terminals Industrials 1.6 0.5 0.6 0.5
TFI International Inc. Industrials 0.7 0.8 1.3 0.7
Toromont Industries Ltd Industrials 1.0 1.0 1.5 1.3
Cargojet Inc. Industrials 1.7 1.5 1.7 0.6
Colliers Intl Group Real Estate 0.2 1.2 6.4 1.1
FirstService Corp. Real Estate 0.4 2.2 9.0 1.9
Altus Group Limited Real Estate 0.8 1.7 6.0 2.0
Constellation Software Technology 1.0 0.9 6.8 0.8
Open Text Corporation Technology 0.5 0.4 0.8 0.5
Enghouse Systems Ltd. Technology 1.0 1.0 1.9 0.7
Northland Power Inc. Utilities 1.5 1.2 3.2 0.8
Cdn Utilities Ltd., A Utilities 1.0 0.6 0.8 0.7
Atco Ltd., I Utilities 0.4 0.5 0.5 0.3

Source: Morningstar CPMS, Data as of March 31, 2021

To understand whether this investment concept was sound, I used Morningstar® CPMS™ to backtest the strategy from December 1992 to February 2021 using a 20 stock portfolio holding no more than five stock per economic sector.  Once a month, stocks were sold if they fell below the top 40% of the S&P/TSX Composite index based on the aforementioned quality metrics, or if all four sector relative valuation ratios exceeded 30% of the sector. Once sold, they were replaced with the next highest ranking stock not already owned in the portfolio. On this basis, the strategy produced an annualized return of 13% while the S&P/TSX Composite TR index produced 8.8%.

This article does not constitute financial advice. It is always recommended to speak with a financial advisor or investment professional before buying or selling any of the securities listed here.

 

About Author

Ian Tam, CFA  is Director of Investment Research at Morningstar Canada. 

 

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