Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about Canadian value equities with William Aldridge, managing director and portfolio manager with Mackenzie Investments. We talked about attractive sectors, AI disruption fears, and the role of value investing. And we started by asking whether after the recent run on Canadian equities, he’s still seeing meaningful upside for value stocks.
William Aldridge (WA): The first thing I would say is that there’s never easy money to be made in the markets. It’s always hard. At certain points in time, it’s easier to find undervalued securities. At other points, it’s more challenging. We are certainly in an environment today when markets are hitting all-time highs. It is more challenging to find opportunities. But on a relative basis, we still do see opportunities. In certain pockets of the market — you can think of the Canadian banks, for example — we see them as fully valued today. But there are pockets of opportunity in the market. One of the things that we have seen this year is a fair number of takeovers of Canadian companies. And that for us speaks to a dynamic where there’s a disconnect between what we call private-market values versus public-market values. We’re seeing private buyers look at public securities and say, ‘There’s value to be had there.’ They’ve launched takeover bids for a number of these companies. That’s particularly the case in the Canadian small- and mid-cap space. So, there is good value to be had in certain pockets of the market but, overall, it has become a little bit more challenging.
How he perceives value
WA: The determination for us of intrinsic value is really what a knowledgeable buyer would pay for this particular company, in this industry, at this point in a cycle. Typically, that’s reflected in a multiple — a multiple of cash flow or earnings — and depending on where we are in the cycle, those multiples can be at the high end or the low end of a historical range. We’re not necessarily looking for quality businesses. You often hear this in the markets — quality businesses trading at a discount to fair value — that’s a perfect scenario for everybody. But in our view, those opportunities tend to get arbitraged away relatively quickly, certainly more so today than they would have 10, 20 years ago. So, we need to be a little more selective about how we think about relative value.
Value in energy and commodities
WA: In the commodities sectors, applying multiples to companies’ cash flows and earnings can somewhat lead you astray from what the true — or again, that intrinsic — value of a company might be. So, we do a couple of things to gauge the value of a commodity company. The first is that we use normalized commodity prices. Take, for example, oil. The price of oil on a spot basis today is not reflective of the more normalized basis of pricing for oil. And if you look forward in the cost curve — kind of the futures market — in oil, you’ll see that those prices are quite a bit lower than where we are today. We think about what a normalized commodity price should be. And we use that in our determination of intrinsic value. We stay away from the application of short-term multiples of cash flows or earnings on short-term earnings because those can be volatile. And the other thing we do is we look at things on a more drawn-out basis, on what we’ll call a net asset value basis. So, when commodities are volatile, the stocks can also be volatile, but we want to stay away from chasing names in the short run, getting either too euphoric, too bullish, or too pessimistic, depending on what we’re seeing, if that commodity price is quite a ways from what we call a normalized commodity cycle.
AI disruption fears
WA: There’s no question that AI has had an impact on the valuations that investors are applying to certain sectors. We’ve certainly seen this in the software space. We’ve seen it in the engineering space. And there’s what we’ll call an overhang right now of uncertainty around what the ultimate outcome will be for those businesses that are subject to the AI risk, if you will. The way we think about it is that the range of outcomes has become wider. There’s no question that AI is transformative, and it will be transformative for many industries. One of the things that we are very much keeping a close eye on and keeping management’s feet to the fire is agility. We want to ensure that companies that we’re investing in are agile. They’re not stuck in the old way of doing things. They’re perceiving and addressing the risks, and [are] willing to take those difficult steps to either transform the company or take a different path, a different avenue and strategy, because they know that the world has changed. The worst situation is if a management team has not recognized the world has changed and is kind of stuck in the old way of doing things while their competitors and industry around them continue to evolve. We make sure we’re investing in those agile companies that are perceiving risk and dealing with it.
The role of Canadian value equities in a balanced portfolio
WA: Canada has always been a wonderful opportunity for investors. Canada has a different profile than many of the markets, and certainly this would be the case relative to the U.S. market. The U.S. market is very strong in growth stocks and technology stocks. And of course, these are areas of the market that we are lacking in Canada. But we have other things to offer. The Canadian investment landscape offers a strong commodity base. Canada is the place to be for exposure to gold companies, for the concentrated exposure we have to energy companies. And this is something that investing in Canada brings to investors: that concept of diversification across sectors. This is something that investors should seek out. They should seek out uncorrelated returns in investment landscapes, and the Canadian market has a differentiated set of returns relative to the U.S. market, depending on what is driving the market cycle. We think there’s a strong role to play for Canadian stocks in investors’ portfolios. We have seen foreign capital and investor confidence improve under the Carney government. We have the commodities that the world needs. And now we are proving to be open for business.
And, finally, what’s the bottom line on investing in Canadian value stocks?
WA: It’s been a great environment for stocks for a period of time here. Canadian equities have had a great run. We’re sitting near all-time highs. And we certainly do see pockets of opportunity in the market. But I think it’s important to recognize that various pockets of the market are also at the high end of their valuation ranges. Investors have just been so risk-on in the market right now. And that for me, well, it’s a red flag. I’m concerned about that. It’s not, in our view, the time to be super aggressive on stocks, so we’ve been reflecting that in our portfolio today. On balance, when we think about those cycles of optimism and pessimism in markets, those cycles of euphoria and everybody running for the exits, we’re closer to that point of euphoria. But at those points in market cycles, it doesn’t take much for multiples to contract. These are risks in the market that we need to be aware of as we build our portfolios.
Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to William Aldridge of Mackenzie Investments. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.
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