David Taylor’s dream stock is one that has growth in earnings and cash flow, trades at a significant discount and for which there is a catalyst that will unlock its value.
“Ninety-nine per cent of the time, you never find them — except for now,” says Taylor, 45, manager of the $840-million Dynamic Value Fund of Canada and vice president of Toronto-based Goodman & Co. Investment Counsel Ltd. “For the first time in my career, I can find growth stocks that are trading at depressed valuations.”
A 20-year investment industry veteran, Taylor looks for mispriced stocks that may not appear on other investors’ radar. “I’m deep-value, event-driven and like cheap stocks that have ‘warts’ on them in the short term,” he says, “Our analysis tries to determine whether these warts are permanent or temporary.”
Although the macroeconomic environment is profoundly gloomy, Taylor has snapped up such U.S. household names as Johnson & Johnson Co., Nike Inc. and Home Depot Inc. Other holdings in the 35-stock Dynamic fund include Canadian firms Eldorado Gold Corp., HudBay Minerals Inc. and Research in Motion Ltd.
Established in 1957, the fund is one of the oldest in Canada. It has had an average annual compound return of 11.1% since inception. Taylor, who took control of the portfolio in January 2003, has delivered strong long-term returns relative to the fund’s peers. For three years ended Dec. 31, 2008, the fund posted an average annual compound loss of 1.4%, vs a 6.3% loss for the median fund in the Canadian focused equity category. Over five years, the Dynamic fund posted an average annual compound return of 8%, vs 1.3% for the median fund in the category.
In the past 12 months, however, Taylor has been stymied by market conditions and some ill-timed bets. His fund lost 28.2% for the 12-month period ended Dec. 31, vs a 30.4% loss for the median fund. But he believes the Dynamic fund is positioned to make up for lost ground.
The fund has a five-star Morn-ingstar Canada rating.
In the short term, some analysts are cautious about this fund. Gordon Pape, fund analyst and publisher of the Internet Wealth Builder in Toronto, observes that preserving assets has been one of the toughest challenges in the bear market. “On that basis,” he says, “Taylor gets a C+.”
Over the long term, however, Pape says, Taylor has fared better: “He rates an A. He’s an excellent manager.”
Dan Hallett, president of Wind-sor, Ont.-based fund indus-try analysts Dan Hallett & Associates Inc., also gives Taylor high marks: “He’s one of the better managers out there.”
The Dynamic fund has suffered in the past year, but Hallett is confident it will recover: “Taylor is one of the more passionate, competitive and skilled value managers. I hold him in high regard.”
A bottom-up manager, Taylor is risk-averse in a highly volatile environment. First, with a view to maximizing opportunities outside Canada, about 25% of the fund’s assets under management is in foreign content. Second, Taylor has partially hedged that exposure back into Canadian dollars to mitigate currency fluctuations. Third, although he generally looks for stocks across the market capitalization spectrum, the fund is currently focused on large-caps, which account for 70% of the fund’s AUM. A blend of mid- and small-cap companies accounts for the rest.
“The largest, most liquid names are trading at incredibly cheap valuations,” says Taylor. “So, there is no reason to take risks with smaller-cap stocks.”
Sector weightings are limited to 25% of the fund. “This is a core fund. Being a manager is not only about picking stocks,” says Taylor, who is part of the seven-member value team. “It’s also about managing the portfolio and understanding the correlation between sectors. You may say, ‘I’ll limit my exposure to energy and go long on base metals.’ But if base metals and energy are closely correlated, then all you’ve done is added more energy.”
Last summer, when the fund’s energy weighting hit more than 30%, Taylor reduced it to 15% and raised cash. During September and October, he bought gold and agricultural companies — somewhat prematurely, as it turned out. “I would have done better if I had waited,” he says. “But I am willing to take short-term pain to establish a good long-term track record. You have to be contrarian and be fully invested when the market is crashing, and take money off the table when the market is frothy.”
@page_break@A Toronto native, Taylor had initially planned to become a doctor but changed his mind while completing a bachelor of science degree at the University of Western Ontario in 1986. Instead, influenced by his grandmother, he turned to money management. “She used to be give stocks for my birthday,” he says. “That’s how I got interested in investing.”
After getting an MBA from Toronto’s York University in 1988, Taylor landed an equity analyst position at Confederation Life Insurance Co. of Toronto. “I loved it,” he says. “There were 12 analysts, all young. The portfolio manager was very intimating and we’d spend six weeks researching names.”
Taylor developed an interest in deep-value investing. In 1991, he joined the Ontario Teachers’ Pension Plan Board and, for the next four years, co-managed Canadian large-cap and small-cap funds. In 1995, he moved to Toronto-based Altamira Investment Services Inc. and managed resources and Canadian value funds. In 2002, he joined Goodman & Co.; Taylor now oversees about $3 billion in AUM, including Dynamic Canadian Dividend Fund and Dynamic Dividend Value Fund.
During last fall’s bear market, Taylor bought U.S.-based names, including Home Depot. “It is debt-free and is a significant player in the home-improvement market,” says Taylor. “It also owns all of its real estate, which is a significant hidden asset and probably worth half the stock price if [the firm] ever did a sale and lease-back.”
Taylor bought the stock at US$20 a share, a price/earnings multiple of 10. Historically, the stock has traded at 15 to 20 times earnings.
What’s the catalyst that will drive the stock up? “The market is discounting a continuing decline of 20% in existing home sales year-after-year. But I believe you will [soon] see year-over-year improvement,” says Taylor. “I can’t predict when the deceleration of existing home sales will stop. But I do know that the affordability index is back at levels last seen in 2002.”
Taylor notes that even if the home-improvement market remains depressed, Home Depot is profitable. And that’s what matters most to him: “Right now, it’s all about owning companies that have clean balance sheets and will survive. When things get back to normal, [Home Depot] will make significant amounts of money again.”
Taylor anticipates moderate downside at current levels. Home Depot shares were recently trading at US$21.85 each. His 24-month target is US$45 a share.
Taylor also likes Freeport-McMo-Ran Copper & Gold Inc., the world’s lowest-cost copper producer; its annual output is 4.5 billion pounds. The company also produces two million ounces of gold a year. “It’s a survivor,” says Taylor.
Freeport’s stock hit a 52-week high of US$127 a share in June 2008, then tumbled to US$15 in November. Taylor began buying at US$16 and has seen the stock rise to its recent price of US$22. His 12-month target is US$32 a share.
“The biggest concern is that the company has US$7 billion in debt,” Taylor says. “But it does not have to make any significant debt payments until 2012. My sense tells me we will see another copper market before then.”
Taylor limits single holdings in the Dynamic fund to about 6% of AUM. Turnover has been moderately high: 90% for the year ended June 30, 2008. It was 57.9% in 2007.
“We try to hold names for three years,” says Taylor, adding that his objective is a 50% return over three years. “Sometimes, they reach their target in six months. When stocks are fairly priced and we see other opportunities, we’ll take profits.”
Taylor is continuing to hold several names in the agriculture sector that he bought last fall, including Potash Corp. of Saskatchewan Inc. and Mosaic Co. He has also invested in the gold sector via Eldorado Gold Corp. and Barrick Gold Corp.
“I thought these two sectors would withstand an economic slowdown,” says Taylor. “The stocks were already down [by] 50%. Grain crops were at record lows, farmers’ profits at record highs and people are still going to eat. This was a conservative way to invest in cheap companies that were trading at record-low valuations.”
To Taylor’s chagrin, the agri stocks fell by another 40%. Gold stocks fell, too, as investors flocked to the perceived safety of the U.S. dollar. But Taylor is hanging tough: “I didn’t see that the US$ would do as well as it did. But when we look back in six months, we’ll say it was a good call.” Barrick’s share price was recently $45, after bottoming at $22 a share in October.
On a sector basis, there is 14% of AUM in materials, 15% in gold, 21.6% in energy, 17.3% in financial services, 9.5% in consumer staples, 5.5% in industrials, 5.2% in consumer discretionary and smaller weightings in health care and telecommunications.
Looking ahead, Taylor is bullish. He argues that the market has discounted a lot of bad news — and then some. “It’s way oversold.” he says. “Eventually, we will get out of this and the market will look beyond 2009.” He expects the slowdown to continue for most of this year: “If history is our guide, the market will discount the recession six months before it ends. Sometime in June, we’ll probably see the bottom.” IE
Deep-value, event-driven manager
David Taylor steers Dynamic Value Fund through treacherous markets
- By: Michael Ryval
- February 6, 2009 October 30, 2019
- 14:47