Matt Kacur, president of FSA Financial Science and Art
Focus: North American equities

MARKET OUTLOOK

We think the downside risk still outweighs the upside potential in the next six on eight months. The recent pullback beginning in October where the S&P 500 and the NASDAQ drop by 10.2 per cent and 14.4 per cent respectively was long overdue. It’s healthy and was even predictable. Predictable is a strong word when it comes to exact timing, but it was clearly coming. In all our published work for the past year or more we had been cautioning about nearing top. We suggested the tax cuts would do more damage than good by ballooning the deficit. In addition, interest rates were telegraphed by the U.S. Federal Reserve to rise, trade wars were heating up and valuations were stretched. Now, those obvious issues are finally being recognized the market. So, the obvious question after the pullback: is it time to get back in? In our opinion, no; it’s simply too early. Markets don’t simply drop and bounce back just as quickly. Typically, it takes time for them to adjust to the new reality. Markets are most volatile at the top and at the bottom. With the S&P 500 only down 10.4 per cent and the NASDAQ only down 14.4 per cent, there is more downside risk in our opinion.

TOP PICKS

DUNKIN BRANDS (DNKN.O)

Dunkin Brands has plans to grow its business in the U.S. by 1,000 stores by the end of 2020, which is about 11 per cent growth. 90 per cent of the growth will be outside the Northeast, an effort to become a true national brand. In addition to growth in the U.S., the Dunkin Brand is growing in U.K., Brazil, China, Middle East and testing new international markets. The company consistently produces a good return on capital thanks to its asset light model, where 100 per cent of the stores are franchises. With modest forecast assumptions, we get a fair value of about $85 representing upside of about 20 per cent from its current trading value.

IDEX (IEX.N)

IDEX is an industrial company in three major lines of business:  fluid and metering technology, health and science technology, and fire and safety. The most impressive feature of this company is their ability to produce consistent results. Our work shows the company producing a minimum 15 per cent return on capital for over 20 years. In the trailing four quarters, the company produced a 28 per cent return on capital. The company has a clean balance sheet with a 10 per cent debt-to-market equity ratio and strong working capital position. The company pays a small dividend yielding 1.2 per cent, but it’s growing at about 10 per cent.

NEXTERA ENERGY (NEE.N)

99 per cent of the electricity the NextEra produces is from clean renewable resources like wind, solar and nuclear. In fact, they are the world’s largest producer of wind and solar energy. The company is based in Florida and operates across U.S. and Canada. In our work, we see a history of low but consistent returns with a low premium to invested capital, a key valuation metric for a utility in our work. The current premium to invested capital is 27 per cent, which is a very acceptable number for the industry. Trading in the stock is very consistent with low volatility and few pullbacks. The company pays a dividend yielding 2.43 per cent and is growing consistently at about 10 per cent including 13 per cent in the trailing 12 months. Our intrinsic value is $208 representing about 17 per cent upside from the current trading price.

PAST PICKS: OCT. 13, 2017

ALIMENTATION COUCHE-TARD (ATDb.TO)

• Then: $60.38
• Now: $66.07
• Return: 9%
• Total return: 10%

BROADCOM (AVGO.O)

• Then: $247.96
• Now: $236.13
• Return: -5%
• Total return: -2%

GENERAC (GNRC.N)

• Then: $50.58
• Now: $55.04
• Return: 9%
• Total return: 9%

Total return average: 6%

WEBSITE: www.fsavaluation.com
TWITTER: @mattkacur