Mar 1, 2017

Barry Schwartz's Top Picks: March 1, 2017

BNN Bloomberg

Barry Schwartz , BNN

Barry Schwartz, Chief Investment Officer, Baskin Wealth Management

FOCUS: North American Large Caps

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MARKET OUTLOOK:

The North American markets have had quite a run over the past four months, so it’s natural to wonder where we go from here.

In ordinary circumstances, many of the current issues in the markets would be cause for concern: Valuations are higher than they have been in years, markets are responding positively to Trump policies and seem to be ignoring all the negative possibilities. It is easy to imagine that we are due for a meaningful pullback, and it seems risky to commit new funds to the market.

Only hindsight can provide answers to these kinds of concerns, but that’s ok—a good investor always worries about what could go wrong.

Let’s spend a few minutes worrying about what could go right:

1. We have seen stellar results from many of our portfolio companies in their latest financial reports. CEO’s are providing confident outlooks for the rest of the year and are backing it up with dividend increases and continued share buybacks. Perhaps we should worry that markets aren’t expensive enough, and until other investments provide sensible returns for your capital, the market has nowhere to go but up. After all, with “safe” investments like bonds, you’re lucky if you get slightly over 2 per cent; after paying fees and taxes, and accounting for inflation, you’re actually losing money. It doesn’t seem sensible to commit capital to investments that guarantee such poor returns when good quality stocks are providing rising dividends and rising earnings.

2. In the last few months, the U.S. economy has really started to pick up. We are seeing real signs of increased growth in manufacturing, industrial output and job creation. Recent surveys of consumers, small businesses and architects show people are feeling more confident about their future. Also, the recession that we saw in Alberta during 2015/2016 is over, and the price of oil and other commodities have recovered to more comfortable levels. Overall, the North American economy is finally set for solid growth, and this should lead to expanding corporate profits. Perhaps the market is being too conservative and not pricing in further upside for company earnings, which remain the primary driver of stock prices.

3. This one is the elephant in the room. Donald Trump. It seems to us that Trump has surrounded himself with a number of “adults” who actually do have a handle on the economy and business. Whether there is a massive infrastructure boom, or if corporate taxes will drop, or both, perhaps we should worry that Trump may actually become the pro-business President the market wants him to be. As a result, businesses would have the confidence to expand and hire new employees leading to the kind of economic growth that we haven’t seen in over ten years.

The next four years are going to be very interesting for investors. I remain skeptical, as any good investor should, but I am also open to the possibility that more can go right than wrong.

Top Picks:

National Bank (NA.TO)

Forward P/E: 10.5x P/B: 1.75x Dividend yield: 4.1 per cent

We continue to like National Bank at a discount to the banking sector, which provides healthy dividend yields in a low-rate environment. The main concern for National was its exposure to energy loans in Western Canada. Those concerns are now off the table. National’s capital ratios continue to improve, and is now at 10.6 per cent after reporting results today. This put it in a good position for larger dividend increases and share buybacks. National also has less exposure than most other banks to the Ontario real estate market, with Ontario only making up 25 per cent of their mortgage portfolio. National should be valued in line with the rest of its Canadian banking peers.

Neenah Paper (NP.N)

Forward P/E: 17x, EV/EBITDA: 9x, Dividend Yield: 2 per cent

Despite its name, only half of Neenah Paper is traditional paper products. The other half comes from industrial and performance-based technical products such as filters. Over time, Neenah is expected to harvest cash from the declining paper business to invest in technical products, which should result in a valuation closer to industrial products companies. Neenah is a well-run business that allocates capital in an efficient manner, and has kept debt levels low despite a solid track record of M&A. Neenah Paper has raised its dividend every year since 2012, and we expect this to continue as Neenah grows its free cash flow. The shares have been on a bit of a slump since the beginning of the year, and we think this is a good buying opportunity.

TMX Group (X.TO)

Forward P/E: 14x, EV/EBITDA: 11x, Dividend Yield: 2.6x

We continue like stock exchanges because they are capital-light businesses that generate lots of free cash flow. With its balance sheet in great shape, we see the potential for yearly dividend increases, share buybacks and M&A opportunities. There are concerns over potential competition from NASDAQ, but we believe there are massive advantages to being the incumbent exchange. TMX has done a good job of streamlining the core business and re-focusing on providing liquidity for its listed companies. At 14x forward earnings, TMX is still trading at a large discount to U.S. peers.