Ryan Modesto, chief executive officer at 5I Research
Focus: Canadian small- and mid-cap stocks

MARKET OUTLOOK

As we approach year-end, investors seeing year-to-date results for the TSX at roughly 16 per cent might be disappointed when they log into their bank account, as a lot of the gains were due to fortuitous timing of the calendar year-end. In fact, over a two-year period, the TSX is only up roughly 3.5 per cent before dividends. If your portfolio doesn’t “feel” much larger than before, you can be reassured that it might be because the TSX isn’t actually much higher aside from a fortunate timing benefit. Regardless, the index continues to bump up on all-time highs and there are bright spots within it.

As investors begin to calibrate their portfolio for the New Year, we think it is important to hone in on what takes the markets higher. On a broad basis, we continue to think the structure of the TSX (60 per cent financials, energy and materials) makes it difficult to expect particularly compelling results, but there are bright spots. The tech sector is up roughly 46 per cent year-to-date and 58 per cent over two years. We view this space as having the qualities that investors should be looking for across all sectors:

• Good growth.
• High and stable margins.
• Access to international markets.
• Balance sheet flexibility.

Markets are starting to peel back the layers of stocks and scrutinize companies and their valuations more. We think companies with good margins, an ability to grow and flexibility to invest resources in what is working will be rewarded in the New Year and beyond.

Taking a more macro viewpoint, the economy is slowing but the key is that it continues to grow and, while recession fears remain, the data points continue to chip away at fears of some large or ominous downturn. We think investors need to start thinking that if a recession even does occur, what “type” of recession is it going to be? Not every downturn is like 2008. We think the chances that markets might end up in a technical recession anchored by some select industries are growing, but the impact will remain isolated to those areas alone. If this is the case, investors need to evaluate to what degree this is already being priced in and one’s ability to even time this right in the first place.

TOP PICKS

KNIGHT THERAPEUTICS (GUD:CT)

A long-awaited deal from Knight Therapeutics has finally occurred and markets received the news well. We do not think the story is done here though. The company will still have roughly 20 per cent of their market-cap remaining in cash when the deal is completed and once the acquisition is fully integrated, it should be trading around 15 to 18 times EBITDA before considering potential growth. The company has now transformed to a revenue-generating business while still having some optionality with the cash balance and no debt.

TMX GROUP (X:CT)

TMX offers stability in a market where investors are nervous. The company has tended to increase dividends annually and is a unique asset in a space that has been seeing consolidation. Margins are stable, the balance sheet is well managed and is seeing success with its Trayport business. TMX also trades at a discount relative to most of its peers.

LIGHTSPEED POS (LSPD:CT)

Lightspeed is one of the fastest-growing names on the TSX. It offers point-of-sale solutions for businesses that also track orders, offer analytics and help businesses manage inventory. Gross margins are in the 70-per-cent range and the company is investing heavily in growth. It recently rolled out a payments business that is seeing success and is using its cash to buy complementary businesses, which should also support growth. 90 per cent of the business is recurring in nature and there is no debt on the balance sheet. The one caveat here is that this company is not yet profitable and sports a high valuation and, in turn, is higher risk and volatile. So, while an investor might expect good things from this name, it will not necessarily be a “smooth” path to get there.

PAST PICKS: NOV. 29, 2018

SAVARIA (SIS:CT)

• Then: $13.20
• Now: $13.90
• Return: 5%
• Total return: 9%

ANDREW PELLER (ADW/A:CT)

• Then: $14.01
• Now: $12.71
• Return: -9%
• Total return: -8%

A&W REVENUE ROYALTIES (AW-U:CT)

• Then: $34.37
• Now: $37.77
• Return: 10%
• Total return: 15%

Total return average: 5%

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