To achieve long-term success, conservative clients should load their portfolios with stocks bought at low price/book value multiples and with low price volatility. This is what stock market wisdom revealed many decades ago, and what numerous academic studies have since validated.
You can always find stocks trading fairly close to book value, and there are always stocks whose price gyrations year in and year out have been fairly modest. The two qualities together? Not in this hyper-bull market.
To employ this strategy today among the 75 or so largest stocks in the Canadian market, your portfolio would begin with just three stocks. Two are utilities based in the Atlantic provinces, the third is a Quebec-based bank.
These stocks — Fortis Inc., Emera Inc. and National Bank of Canada — combine both low prices relative to their book values and a history of relative price stability.
If you choose from stocks with ratings not quite as low as these, there are two more that combine both attributes: Alberta-based Atco Ltd. and Canadian Utilities Ltd.
The accompanying table shows what you find in analysing stocks in the S&P/TSX 60 index (large-cap stocks) and some of the largest stocks in the S&P/TSX continuation index, a made-over version of the former mid-cap index.
Industry turnover is a big problem in trying to match stocks with low price/book value ratios and relative price stability. Many big-name Canadian stocks have disappeared, and many of the market’s largest stocks are fairly new. That includes insurance companies, income trusts, mining companies and new-to-the-market retailers such as Shoppers Drug Mart and Rona Inc.
To measure price stability, we have used 11 years of annual data and run them through an original Value Line Investment Survey formula (see Investment Executive, June 2004). This automatically excludes the market’s recent recruits.
Arnold Bernhard, Value Line’s founder, discovered through extensive research that the single best tool for identifying stocks with the highest quality is price stability. It is even more significant than earnings growth.
Bernhard’s formula, published almost 50 years ago, is as good as new. It takes into account not just annual price movement but also the secular trend in a stock’s price. In other words, a growth stock does not show up as being volatile just because it has gained rapidly in price.
Choosing stocks priced at a low multiple of book value of common shareholders’ equity was pioneered in the 1930s by investment guru Benjamin Graham and his associates. Graham’s goal was “margin of safety.” Later, researchers showed that portfolios consisting of stock with low price/book value ratios outperform the market over the long haul.
Put these two ideas together — price stability and low price/book value — and you have a great combination for conservative investors with long-term results in mind.
For a long time, one of Wall Street’s secrets was the stability and long-term investment appeal of its big integrated oil stocks. The growth of Suncor Energy Inc. has put that company into a similar position, along with Canadian integrated companies Petro-Canada and Imperial Oil Ltd.
Not far behind Suncor in improved price stability are EnCana Corp. and Nexen Inc. This suggests Suncor, EnCana and Nexen will remain appealing “buy” candidates in the future, even if oil and gas prices drop.
On a price/book value basis, however, Nexen has current appeal. It trades at less than twice book value. On this basis, the others are not as attractive, with Suncor at almost five times book value, and the others around three times book value.
The combination of low price/book value and low price volatility favours utilities and pipelines, especially mature companies. That’s why Nova Scotia-based Emera and Newfoundland-based Fortis fare so well in these comparisons. The strategy also identifies banks and other financial services companies as high in investment quality.
Nudging into the ranks of major companies with low price volatility are SNC-Lavalin Group and Brookfield Asset Management Inc. SNC-Lavalin is best known as the operator of Ontario’s 407 toll superhighway, but its major businesses are engineering and construction. Brookfield has utilities-like attributes, as well as land and property investments.
Because of SNC-Lavalin’s and Brookfield’s subdued price volatility, they — like Suncor, EnCana and Nexen — should have future appeal when they trade closer to their book value. IE
The smart way to long-term investment success: Included Chart
Choosing stocks with low price/book value multiples and low price volatility is key
- By: Carlyle Dunbar
- July 31, 2007 October 31, 2019
- 11:58