Mike Newton's Top Picks: December 5, 2017

Mike Newton, director of Wealth Management and portfolio manager at Scotia Wealth Management
Focus: North American large caps and ETFs
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MARKET OUTLOOK

It's a curious environment. The year's best-performing stock groupings have been the worst in recent days. I believe an investor's time horizon should determine their focus on these recent tax policy changes. Over the near-term, I see volatile adjustments as company-level impacts come into greater focus. However, for those investors with a longer-term view - say, greater than six months - a reduction in taxes should be secondary to underlying business dynamics.

If I may use an analogy of comparing stocks to cars – the price of gasoline has just been reduced (tax cuts), but has the fuel efficiency of your vehicle actually improved? I would refrain from trying to pick the ultimate winners and losers of the tax bill, as investment decisions should be based on more than just the amount of tax paid. A diversified portfolio wins the day and techs are still a force to be reckoned with based on their powerful fundamental growth and earnings momentum. They won’t stay underperforming for too long. I quite liked a recent note from J.P. Morgan saying the stock markets may start undergoing a “value squeeze” that could last for some time. This is constructive as it broadens the market foundation and breadth increases. This may also be beneficial to the Canadian markets where there tends to be quite a bit of value in comparison to the U.S.

TOP PICKS

DIGITAL REALTY TRUST (DLR.N)
Digital Realty Trust is a real estate investment trust that focuses on data center properties. The world is using an increasing amount of technology, which requires businesses to use more computing and server power. But owning specialized buildings and the necessary hardware to keep them running is an expensive proposition. That’s where Digital Realty comes in. DLR owns more than 150 data centers across the world. The steadily increasing need for data housing and server hosting has translated into steady growth. Revenues are up by nearly 50 per cent over the past three years, and earnings have climbed by more than 35 per cent in that time. Those profits also have gotten a lift as Digital Realty has moved into complementary businesses, like offering IT solutions to its customers. Those higher-margin businesses have helped pad the firm’s growing dividend, which currently yields 3.3 per cent. In recent days, because the company has a very low effective tax rate of three per cent or so, the shares have come under pressure. This is a buying opportunity. Most recent purchase on September 27th, 2017 at US$114.

FRANCO-NEVADA (FNV.TO) 
Right now gold and precious metals are not on most investors' radar screens. And so as they say, “the time to get interested is when no one else is.” As viewers know, I am not always enamored with highly cyclical oil, gas, metals and mining sectors due to the volatile nature of these sectors. However, the steadier nature of FNV fits the bill for me if and when I want exposure to precious metals. Franco-Nevada is a precious metals focused royalty and streaming company with some interests in platinum, oil and gas. As a royalty-streaming company, FNV's business model has several attractive features of which the most appealing to me is its asymmetric risk profile, since it generally does not need to contribute additional capital (beyond its initial investment) to fund further exploration and development.

FNV has a very strong and growing portfolio that includes many large positions in tier-1 assets that have low costs and long mine lives. Management expects its annual production rate to grow substantially over the next several years. FNV has continued to distinguish itself from peers by pivoting towards oil and gas assets during a period where transactions for precious and base metals assets had been less attractive. With over $1.5B of available liquidity we expect management to be selective with their acquisitions. Most recent purchase on May 15th, 2017 at $98.

HOME DEPOT (HD.N) 
Home Depot has had a strong run this year as a tightening labour market and a historically low level of homes on the market has prompted consumers to spend more on their houses. The types of items that the group sells, such as lumber and appliances, has also shielded it from e-commerce competition from Amazon that has roiled other retailers. But here is the problem – shares are at an all-time high. With valuation at a multi-year high, and investors debating where we are in the housing and investment cycle, the question is whether to stay on board in 2018. For long term investors I think this is a classic case of "business as usual," and shares should continue to be part of a well-diversified portfolio. I wouldn’t be too concerned if we see a shallow pullback from these levels as I expect double digit forward growth for years to come. It is estimated that HD shares have an effective tax rate of 36 per cent. Most recent purchase on October 20, 2017 at US$165.

PAST PICKS: NOVEMBER 8, 2016

ALLIED PROPERTY REIT (AP_UN.TO)

• Then: $34.57
• Now: $41.67
• Return: 20.53%
• Total return: 26.00%

ROPER TECHNOLOGIES (ROP.N)

• Then: $174.04
• Now: $258.21
• Return: 48.36%
• Total return: 49.32%

DIGITAL REALTY TRUST (DLR.N)

• Then: $94.88
• Now: $113.05
• Return: 19.15%
• Total return: 23.23%

TOTAL RETURN AVERAGE: 32.85%