Transcript: Index funds leading to greater volatility
- June 8, 2021 June 7, 2021
Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.
In today’s episode, we talk about stock picking with Joe Sirdevan, CEO of Toronto-based Galibier Capital Management. We discuss some recent investment trends, what Canadian stocks he likes, and how he pegs corporate value. We started by asking what he looks for in stocks.
Joe Sirdevan (JS): A demonstrated competitive advantage which is enduring. It has to have a management team with a demonstrated record of maximizing on that competitive advantage. Strong E, S and G principles that it follows. We need companies that generate a high degree of economic earnings, and we would define that as free cash flow from operations, less the necessary capex to support our drivers of growth. We need to have companies that have an appropriate or better amount of financial leverage, so we take no balance sheet risk whatsoever. And, finally, we’re looking for businesses that have above-average long-term growth prospects. So once a company has demonstrated all five of those criteria, then it gets added to our investable universe. And then we try and buy the ones that trade at the greatest discount to our estimate of intrinsic value.
What Canadian companies are attractively priced right now.
JS: Just three names that stick out to me right now that I think are materially undervalued, would be Premium Brands, which is a producer of processed meat, seafood, ready-to-eat sandwiches. They are a huge supplier to Starbucks. That stock is currently trading around $118 or so in the market, and our estimate of intrinsic value, using about a 13% discount rate, is around $124. So, we think that stock, even at $124 offers value and we’re buying it at $118 so certainly discounted to [its] intrinsic [value]. Another name is Parkland, an operator of North American and also some Caribbean convenience stores. And that stock is currently trading around $39 or so, and our estimate of intrinsic [value] is around $46.75. So, again, lots of upside in that name. And then a company that a lot of Canadians love to hate, Rogers Communications [Inc., based in Toronto]. The intrinsic [value] is around $71, currently trading at $61, so we see some good upside in that name as well.
What about the rise of passive funds?
JS: We’ve seen the rise of passive index products — that’s been happening for the last 30 years, 40 years even — but they are now at a level where they are becoming massively influential in setting the price of securities because they are such a large proportion of the investing dollars at work. So, they’ve gone from being price takers to being price makers. They’re not really focused on the fundamentals of the company. An index fund seeks to reproduce the weight of the company in the product. So, if Shopify is 7% of the Canadian index, then for every $100 that flows into an index-linked product in Canada, $7 of that goes to buy Shopify. And it doesn’t care if Shopify is at $1,200 or $1,800. That’s an interesting phenomenon, when a passive product is making valuation decisions. It leads to enhanced volatility. And volatility is the friend of the long-term investor. If people are doing crazy things, or computers are doing crazy things, then you ultimately have the opportunity to take advantage of Mr. Market
On the gamification of investing.
JS: We’ve now got a bunch of people who are new to the market, who are really treating investing more like a proxy for gambling. And you know, the market has been up, up, up. So, everyone is feeling very good about themselves. If this reverses, people are going to be facing real losses, and if people are doing it on [a] levered basis, that’s even more devastating. That’s not going to be in society’s interest I don’t think.
And finally, what are the key principles of investing?
JS: You’ve got to define a circle of confidence where you believe you have an edge in valuing companies. You’ve got to understand them and you’ve got to value them in a rational way. And then try and put together a portfolio of companies that give you the biggest difference between market price and that intrinsic value that you have calculated. That’s the key to investing.
Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Joe Sirdevan, CEO of Galibier Capital Management.
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