As the markets continue to tumble, there are more and more potential opportunities popping up, and it’s important that investors realize that as stocks fall in price, so too does the risk of investing in stocks. This is a hard concept to grasp for many beginner investors. But for experienced ones who have witnessed multiple drawdowns, it becomes more obvious.
Lots of investors want to buy stocks on the way up, and lots want to sell stocks on the way down. Our brains are wired for instant gratification, and to truly succeed in the markets, you have to be able to defer some of the gratification and accumulate during market slides.
Many investors believe that buying stocks during market drawdowns seems crazy. But to investors who are savvy enough to understand that lower stock prices ultimately equal higher future potential returns, it becomes relatively clear they should be buying, not selling. We hope as a member here at Stocktrades Premium we’re helping you to develop this type of mindset.
Canadian Foundational Stock mid-year review
We figured now that we’ve hit the midway point of the year, we’d do a two-part series on our Foundational Stocks both here in Canada and the United States. From the feedback we’ve got from members, many have been adding to these positions over the duration of the year and want to know what the best opportunities are right now.
But first, a highlight on the multi-year performance of our Canadian Foundational Stocks here, as they continue to outperform every major North American Index in every year since their inception, highlighting the importance of developing a core portfolio.
Here is 2020:
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Here is 2021:
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And here is 2022:
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With that said, let’s take a look at how the 11 Foundational Stocks are performing this year, and which ones present some value at this time. Next week, we’ll go over our US options, where the markets have dipped by much wider margins.
Constellation Software (TSE:CSU)
Constellation Software has had a relatively rough year, being down 18%. However, when you consider that XIT, which is an ETF that contains all of Canada’s best tech stocks is down 39%, we can start to see why we consider Constellation a Foundational Stock. Even more alarming is that Constellation makes up over 25% of XIT. So, XIT’s losses would be much worse if it didn’t have this blue-chip tech stock as a top holding.
Overall, when we look at the opportunity with Constellation, we do see one over the long term. The company is now trading at 25 times trailing free cash flow. This is a slight premium to many of the big tech giants in the states (Alphabet, Apple, Microsoft) but the kicker here is none are expected to grow as fast as Constellation. This is one of the best management teams in the country that has put up outstanding returns on invested capital through an aggressive growth by acquisition strategy. We can’t see this stopping anytime soon. Historically, price points like this have proven to be long term buying opportunities.
Granite REIT (TSE:GRT.UN)
Industrial REITs were all the rage after the COVID-19 pandemic. Retailers like Amazon, Walmart, and Home Depot were expected to need a significantly higher amount of warehouse space to accompany the surge in demand for e-commerce. This thesis is still well intact. But now, the narrative has started to fade, rising interest rates are becoming a concern, and REITs are under some pressure. This is good news for current and prospective holders of Granite. Why? Because you’ll be able to get an outstanding company at cheaper prices.
Granite is the number 1 ranked REIT by our REIT screener, primarily due to the fact that it is trading at an 11% discount to NAV, has an 11-year dividend growth streak, has some of the best in class debt ratios, and is trading at only 16 times funds from operations. When compared to its closest competitor, Dream Industrial REIT, which is trading at 17.3 times FFO, Granite is the cheaper and better-capitalized play at this time. The company is quickly becoming more diversified, and we certainly view this as a long-term accumulation opportunity.
Loblaws (TSE:L)
It’s hard to believe that a “boring” grocer like Loblaw would be the all-star of our Foundational Stocks, but it really has been. The company has outperformed the TSX Index by 57% over the last year, and the “flashy” NASDAQ by a whopping 76%. Because of the company’s performance, it is arguably the most fully valued Foundational Stock on the list.
Trading at only 10.6 times free cash flow, Loblaw is now trading at just a single-digit discount to its 5-year median average. When we added Loblaw to the Foundational Stock list in 2021, it was trading at less than 6.8 times free cash flow, a near 40% discount to its historical averages. That value gap has evaporated, and other grocers, particularly Empire Company (TSE:EMP.A) have started to look more attractive from a valuation standpoint.
However, it’s important to note that valuations are but one piece of the puzzle. Loblaw’s offers a variety of discount brands and stores, while Empire is more along the expensive line of grocers, including Safeway, IGA, and Sobeys. If we do enter a recession, it’s possible Loblaw’s will look even more attractive to consumers. We view both companies as strong options right now, but it’s hard to argue with Loblaw’s moat. As the saying goes, it’s better to pay a good price for a wonderful company than a wonderful price for a good company.
Fortis (TSE:FTS)
Quite possibly the top Foundational Stock that many members own, but nobody talks about, is Fortis. And this is for good reason. It’s just business as usual for the regulated utility provider, and there is virtually no volatility in this stock during this large market drawdown. In fact, it’s in the green over the course of 2022.
In theory, utilities should be impacted negatively by rising rates. However, Fortis has historically been un-impacted by rate fluctuations. As a result, it’s fully valued at this time. In fact, it’s trading at a premium to historical averages. However, with the market being so “risk-off” right now, we’re really not surprised investors are willing to pay a premium for the company’s consistent earnings. Our opinion on Fortis right now? It’s arguably the top Foundational Stock we’d be willing to pay full valuations for, just because “discounts” are rare. And if you own it like both Mat and I do, it’s one we will dollar-cost average for the rest of our investing careers.
Canadian National Railway (TSE:CNR)
We rarely get asked whether Canada’s railway companies are good buys or not. The answer will almost exclusively be yes. The question that comes up most often is which one should I add to my core holdings, Canadian National Rail, or Canadian Pacific Rail.
In our opinion, there is less uncertainty with Canadian National Rail right now, particularly due to the fact it didn’t end up closing on the acquisition of Kansas City Southern. That achievement goes to CP Rail. Although make no mistake about it, the acquisition could do well for CP over the long term. We aren’t writing it off, we’re simply noting that there could be some issues in terms of integration.
As for valuation, CN Rail is the better value on almost all fronts. It is trading at 27.4 times cash flow, and 21 times earnings. CP on the other hand is trading at 29x and 23x respectively. Considering these companies both operate a wide range of track across North America, it is not an outlandish thought to hold both.
Royal Bank of Canada (TSE:RY)
At one point, rising rates were a financial sector tailwind. Banks and insurers were cruising to close out 2021 as loan margins were set to improve. However, after realizing inflation was much worse than expected, the Bank of Canada has rapidly increased rates to the point where the market is now pricing them in as a headwind. That’s because these rising interest rates could ultimately drive the economy into a recession. Which, typically wouldn’t be good for financial stocks.
Is Royal Bank currently the most expensive Canadian bank on a trailing twelve-month basis? Yes. But could its brand, size, and exposure to nearly 40 other countries help it perform better in a recession than any other of the major banks? It is likely. And this is exactly why we see Royal Bank being the best performing bank on a year-to-date and 1-year basis. Whereas a bank like CIBC (TSE:CM), which has a much higher concentration in a single economy (Canada) is the worst-performing.
The market is pricing in some pretty significant headwinds for banks over the coming years. We feel these years will be the perfect opportunity to simply dollar-cost average and grow a bigger position in some of the best companies in the country.
Brookfield Renewables (TSE:BEP.UN/BEPC)
Brookfield Renewables is probably the most volatile stock on our Foundational List, as it tends to move relatively swiftly with the sentiment towards renewables. For example, they were a hot topic in 2020 before fading out for much of 2021, and becoming a hot topic yet again when the war in Ukraine started. This is because rising oil tends to bode well for renewable companies and the narrative of an inevitable shift.
But, rapidly rising interest rates as mentioned in the Fortis section are ultimately a headwind for utilities, and Brookfield Renewables has been under some short-term pressure yet again. However, we’d consider this another great opportunity to accumulate shares of what we feel is the best-in-class renewable power generator on the planet. If you’re not comfortable with the big swings in price on a company like Brookfield, you could look for a regulated utility provider like Fortis or even a combo regulated/renewable power generator in Algonquin Power.
Telus (TSE:T)
After a strong run to start 2022, Telus and the other major telecom companies here in Canada are currently undergoing a pretty large correction, primarily due to rate fears. Because telecom companies carry heavy debt loads, rising rates will no doubt have an impact on earnings. However, their moats are wide enough and their earnings will be stable enough that they should be able to withstand a recession and rising rate environment just fine.
The company’s share price has been impacted even further as of late due to an acquisition of the healthcare company LifeWorks. The digital health sector is undergoing a significant correction, so the market did not like the acquisition at first. But, we feel long-term it will help amplify Telus Health’s growth.
In terms of valuation, Telus is still the most expensive of the Big 3. However, this is because it is expected to put up much larger growth over the next few years than its competitors. We feel the premium valuation is more than justified, and this is a solid buy-the-dip opportunity.
Franco Nevada (TSE:FNV)
Franco Nevada is arguably the least talked about Foundational Stock here at Premium. And although the company isn’t smashing it out of the park, it’s still green on the year which is a huge accomplishment considering most markets are in bear market territory. The price of gold has been relatively flat over the course of the year, however, and Franco Nevada’s oil and gas exposure has given it a bit of an advantage when we look to another popular stream like Wheaton Precious Metals, which is down 11% on the year.
Streamers are especially difficult to value with traditional valuation metrics. However, when we look at historical averages for Franco Nevada, it is trading at a significant discount. In fact, more than 40%. As the price of gold hits its lowest point over the last 4 and a half months, Franco Nevada is facing some pressure. Pressure which has caused it to become attractively valued. If you’re looking for exposure to the material sector without the volatility of a gold producer, Franco is in our opinion best-in-class.
TC Energy (TSE:TRP)
Besides Pembina Pipeline, TC Energy has been the best performing pipeline of 2022. While the TSX is down over 10% YTD, TC Energy sits on returns of 18% and the company finally seems to be putting a lot of organizational headwinds like the Keystone Pipeline behind them.
The growing demand for North American energy right now will no doubt be a tailwind for most pipelines moving forward, and TC Energy’s robust network of natural gas pipelines should certainly benefit. The company is now trading at only 15 times forward earnings, which is a 17% discount to the industry averages and is only more expensive on a forward earnings basis than Keyera in terms of pipelines.
When it comes to Foundational pipeline stocks, we view Enbridge and TC Energy as interchangeable, and wouldn’t fret much over choosing which one to own.
Alimentation Couche-Tard (TSE:ATD.TO)
Prior to its most recent earnings release, Couche-Tard had been having a relatively strong year, with flat returns through the first 6 months. But as with most earnings releases in 2022, cautions of inflationary headwinds, supply chain issues, and the current turmoil in Ukraine have put some pressure on its share price.
Operationally, the quarter was a strong one. The company beat estimates on all fronts and even saw a jump in margins. As for value here, Couche-Tard is trading at a slight discount to historical averages in terms of earnings, and right in line with what the market has typically paid on a price-to-free cash flow basis. So, this is another Foundational Stock we’d deem to be fairly valued at this time. But, we can’t state this enough, buying fairly valued companies with consistent cash flow in this volatile market is not as big of a mistake as lots of investors think it is.
Overall, there are few Foundational Stocks that are not strong opportunities at this point
Although as mentioned we wouldn’t have any problem simply adding these companies to a dollar-cost averaging rotation, from a valuation standpoint Couche-Tard, Fortis, and Loblaws are definitely what we would deem fairly valued.
However, we do understand that members will no doubt be asking what we feel are the best opportunities on this list right now. And keep in mind, when we mean opportunity, we’re speaking about the long-term (5+ year timeline) potential of the company. In this situation, it is hard to argue that Granite REIT, Royal Bank, Telus, and to a slightly lesser degree Constellation Software are attractive opportunities right now.
These are 4 companies that are taking a hit in price due to economic headwinds such as interest rates and recession fears. However, we can let emotional investors bring prices down, all while those who have the patience to withstand market volatility can continue to accumulate at better prices.
