December 2017 Update

We continue to maintain a defensive position across our portfolios. We are holding a larger than usual amount of cash, government bonds, and commodity producers, with a reduced exposure to equities.
I’m having a hard time finding Canadian companies worth buying. While the companies we do hold present a good opportunity for double digit returns, most Canadian companies are priced too high to deliver an adequate margin of safety. As an owner of businesses rather than stocks, I find today’s prices aren’t reasonably discounting future earnings growth nor asset value. Perhaps value investing is permanently broken so that earnings and assets don’t matter, or there is a correction approaching that will remedy market prices to a more reasonable and justifiable level.
For example, it appears to me that the stocks of the thirty largest public companies in Canada could easily lose money for their owners. As a group, these companies have been growing earnings on average about 10% per year and growing dividends by about 7% per year. Let’s assume that in the future these companies will trade at 22 times their earnings, as they do today (giving today’s owners the benefit of the doubt, since 22 times earnings is historically very high). If we compound earnings at 10% per year for the next five years and apply the 22x multiple, and then add up the dividends received along the way, we would find that the intrinsic value (what these businesses are worth) is lower than what they’re trading for today. In other words, today’s stock prices are so high that they’ve already discounted over five years worth of generous earnings growth, leaving no room for error. If future earnings growth comes in even slightly below average over the next five years, or investor sentiment even a little less rosy, these stocks could be valued significantly lower.
What might cause below average earnings growth? The companies together are significantly leveraged, owing $0.80 of debt for every $1 of equity. Canada is now the most leveraged of developed countries, and the third most leveraged of all countries. Recessions are inevitable, and when the next one arrives, it’s reasonable to assume it will be amplified by this historic amount of leverage. Just as leverage boosts returns on the way up, it compresses economic activity on the way down.
In my opinion, the average Canadian investor faces the possibility of a permanent loss of capital at today’s prices. With such a high degree of risk in the general market, I have no interest in allocating my own or your capital in the fashion I see most amateurs and professionals investing today. I believe protecting capital is far more important than the fear of missing out on short term speculative gain.
As Noah can attest, building arks is more important than predicting rain, so I have been spending most of my time evaluating the downside risks of our companies. I believe our holdings including cash, government bonds, energy and precious metals producers, and select “recession-proof” companies are the most reasonable way to reduce risk while maintaining upside potential.

In depth portfolio and company-specific notes are available for clients only.

Interesting links:

Investors today have unrealistic return expectations
For an investment to outperform, it must be perceived as hard to own
Yale’s Swensen warns on “low volatility” investing
Investor cash holdings are at an all-time low
Warren Buffett’s first TV interview, he describes a simple & winning investment strategy

Please let me know if you’d like to chat about financial planning, long term investing, or private investment opportunities.


Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth