Teal Linde's Top Picks: Feb. 26, 2018

Teal Linde, manager of the Linde Equity Fund
Focus: North American large and mid-caps

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MARKET OUTLOOK

Stock selection holds key to long-term success in market marked by high valuations

Stock price returns for the S&P 500 index have substantially outpaced earnings growth in recent years, which has created high valuation levels in the market most recently driven higher by optimism that global economic growth is going to accelerate and that companies will benefit from U.S. corporate tax cuts. These factors may support markets in the near-term, but high valuations today are more evenly distributed across various stocks and sectors than they were during the market peaks reached in 2000 or 2007, which is of concern over the longer-term.

When valuations are high, investors have to be increasingly qualitative and selective. This is the danger in the current trend towards passive investing (where investment is often done without regard to valuation). Broad-based heightened valuations make finding reasonably valued securities more challenging. The task involves carefully looking at the long-term business models and competitive landscapes for companies to find the ones that can deliver the growth necessary to justify their valuations. Applying diligent security analysis is our preferred approach to ensure long-term investment success.

TOP PICKS

FACEBOOK (FB.O)
Last purchased on Feb. 12, 2018 at $175.76.

Facebook is the world’s leading social network company. It also owns the increasingly popular Instagram. With over 2.1 billion users, nearly half of all Internet users are on Facebook spending 20 to 40 minutes per day on average on the site.

Facebook’s growth strategy is straight forward: Build the user base, increase engagement and then monetize. The company is increasingly creating a “walled garden” or “closed city” by offering additional services and conveniences that give people less and less reason to ever leave their Facebook world. Underpinning Facebook’s current investment appeal is the accelerating prices of its digital ads. Facebook’s price per ad rose 42 percent in Q4, 35 per cent in Q3, 24 per cent in Q2, and 15 per cent in Q1, while ad impression growth slowed. Facebook is expected to grow revenue and earnings per share (EPS) 36 per cent and 18 per cent respectively in 2018. Facebook trades at 25 times 2018 expected EPS of $7.25, which is the cheapest the stock has ever traded at on a forward price-to-earnings (P/E) multiple basis since its IPO.

ALIBABA (BABA.N)
Last purchased on Jan. 25, 2018 at $198.73.

Alibaba is a Chinese Internet company with business units ranging from its core e-commerce platforms to supporting businesses such as cloud computing (with over 1 million paying customers), payments and marketing services. The e-commerce businesses, controlling over 80 per cent of China’s online spending, combine to make Alibaba the largest online and mobile commerce company in the world by gross merchandise value.

Alibaba operates under a marketplace model (inventory is sourced via third-party sellers) and partners with third-party logistics providers to ensure delivery to end-customers (it doesn’t own warehousing facilities). The company operates in China through the country’s retail marketplaces comprising three brands: Taobao.com, Tmall, and Juhuasuan. Alibaba is expected to grow revenues and EPS approximately 40 per cent and 28 per cent respectively over the next year, while trading at a forward P/E of 30.

INTACT FINANCIAL (IFC.TO)
Last purchased on Feb. 23, 2018 at $97.68.

Intact Financial is the largest property and casualty insurer in Canada with a mid-teens market share. Its product mix is roughly two-thirds personal lines (auto and home) and one-third commercial lines. The company has well established track records of outperforming the industry's profitability (Intact’s return on equity is over 500 basis points above the industry average over the last 10 years) and growth through a series of acquisitions.

Since its IPO in 2009, Intact has increased EPS at an 11 per cent compound annual growth rate, exceeding its long-term goal of 10 per cent. Intact is able to leverage its scale to achieve competitive advantages in pricing and segmentation (more data, more actuaries and better technology) and claims (through internalizing all functions and supply chain savings), which drives margin improvement. Organic growth is supplemented by earnings accretive insurance company and insurance broker acquisitions. 

Unlike the Canadian banks, Intact also has plenty of opportunities to continue consolidating its still-fragmented industry in Canada. With 70 per cent of Intact’s business in auto (50 per cent) and home (20 per cent) insurance, Intact also provides better downside risk protection if macro conditions worsen, given its defensive attributes operating in the property and casualty (P&C) insurance industry. Its stock has recently pulled back offering an attractive entry position.

PAST PICKS: MARCH 9, 2017

PAINTED PONY ENERGY (PONY.TO)

• Then: $6.04
• Now: $1.87
• Return: -69.03%
• Total return: -69.03%

FACEBOOK (FB.O)

• Then: $138.24
• Now: $184.08 
• Return: 33.15%
• Total return: 33.15%

FIVE BELOW (FIVE.O)

• Then: $38.33
• Now: $66.64
• Return: 73.85%
• Total return: 73.85%

Total return average: 12.65%

FUND PROFILE

Linde Equity Fund
Performance as of  Feb. 16, 2018

• 3 Months: -0.7% fund, 0.9% index
• 6 Months: 6.5% fund, 9.1% index
• 12 Months: 8.6% fund, 6.9% index

* Index: TSX / S&P500 – blended total return including dividends in Canadian dollars.
* The Linde Equity Fund’s returns are net of fees, and include reinvested dividends.

TOP 5 HOLDINGS AND WEIGHTINGS

1. Facebook: 5.3%
2. Royal Bank: 4.8%
3. TD Bank: 4.8%
4. Alphabet: 4.5%
5. Telus: 3.8%

WEBSITE: www.lindeequity.com