I bet this Christmas most wish lists are probably filled with Star Wars movie tickets, unlicensed aerial drones, Nespresso coffee makers, fitbits galore, and oodles of hoverboards. But let’s be real… these are all fads that will someday fade away. This year I’d like to ask you for the gift that keeps on giving. According to my performance I’ve been a good boy so I have two gifts I really want the elves to make, and three others if the first two are hard to find.
The first present I’m looking for under the tree are solid earnings compounders. These are companies with high return on equity and high free cash flow. Ideally they don’t have much debt, and their earnings have been steadily growing over the past five years. I know even you will think twice before giving these away so please know they will find a good home with me.
The next item on my list are earnings growers. These are companies that have been growing their earnings or their cashflow, but don’t necessarily qualify as having high return on equity (yet). I noticed there are two types of growers that really put a smile on faces, according to my friend Peter Lynch: fast growers and stalwarts. The fast growers are usually smaller in size and likely have a new product or innovation taking hold in their market. The stalwarts are generally more established companies that are maintaining the status quo and sell higher turnover products (consumer goods like razorblades or toothpaste, and grocery stores are good examples).
Third on my Christmas wishlist are cyclical companies. I know the Toronto market is already full of them, I’d just like to see them go up this year! We tend to find these in industries such as finance and commodities, along with sectors such as chemicals, airlines, and automobiles. These are called cyclical because they move in cycles depending upon economic growth. I know that cyclical companies are much riskier than the first two, so I promise to very careful and not hold on to them too long before passing them on to someone else.
Fourth on my list are discounted asset plays. Asset plays are companies that are selling for less than the value of their balance sheets. By the looks of things you haven’t been giving these out since the early 1960s when you last gave some to my other friend Warren Buffett. I won’t hold it against you if you can’t find any this year either.
Last on my list are special situations. These include mergers, acquisitions, spin-offs, turnarounds, bankruptcies and other event-driven ideas. I would rather keep things very simple and not have to do much math over the holiday break, so if you’re going to leave me one of these please make it more compelling than usual. And remember I don’t like leveraged balance sheets.
Thanks very much for listening. I’ll leave some milk and cookies, plus a copy of the business section by the fireplace.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.