The Canadian stock market is up 20 per cent from its Christmas Eve low.
Despite the gain, it appears to be reasonably valued. Looking at the exchange sector by sector reveals a bin of bargains.
To get a broad overview, I’m going to start by focusing on larger Canadian companies with market capitalizations (shares outstanding times price per share) in excess of $500-million that have their primary listing on the Toronto Stock Exchange. The S&P Capital IQ database contains 314 stocks that fit the bill (including real estate investment trusts, or REITs).
A good 75 per cent of the stocks were profitable over the past 12 months, which isn’t bad considering the resource-heavy nature of our market. The profitable firms have an average earnings yield of 7.45 per cent, which is equivalent to a price-to-earnings ratio (P/E) of 13.42.
The Canadian market is a relative bargain at 13-times earnings compared with the 2.1-per-cent yield offered by long-term government bonds. Mind you, stocks are also riskier and they are a good deal more volatile than bonds. It’s something that was highlighted by last year’s stock-market downturn.
The accompanying table breaks the market down into 11 sectors. It highlights the number of stocks in each sector along with their average price-to-earnings ratio (P/E) and price-to-revenue ratios (P/R). Both ratios are classic measures of value and are based on trailing 12-month earnings and revenues.
Most of the stocks generated positive revenues over the past year but a couple of sectors were outliers. Roughly 10 per cent of the materials sector (think mining) contains companies sitting on land that hasn’t been put into production yet. Similarly, about a quarter of the health-care sector’s stocks didn’t produce revenues over the past year as companies raced to research new drugs.
Money manager and noted value investor Benjamin Graham preferred stocks trading at less than 20 times earnings. Two sectors currently fail the 20-times-earnings test. They are information technology at 33 times earnings and consumer staples at 25 times earnings. Communications services and industrials are close to the line with multiples north of 19 times earnings. (I decided to not include an average P/E for the health-care sector because only five of the 17 health-care stocks, which includes cannabis stocks, were profitable and half of those traded for more than 80-times earnings.)
The rest of the list is fairly cheap on an earnings-multiple basis. Real estate sports the lowest multiple at nine times earnings and financials trade at 12 times earnings. Mind you, I am concerned that we might be near a cyclical earnings high for real estate. A softening could impact real estate and financial firms alike. A significant downturn might spread into the wider economy, which is something that concerns those of us who are haunted by memories of the 2008 crash in the United States.
Sectors are one thing, but bargain hunters are keen to research the cheapest stocks the market has to offer. The second table highlights stocks with the lowest P/Es in each sector apart from consumer staples, which has two bargains as a result of a tie. (I excluded health care because of its small number of barely profitable firms. I also want to disclose that I own a few shares of Russel Metals: RUS-T.)
Stocks with low P/E ratios – as a group – have performed well over the long term. But it’s worth pointing out that the good long-term results came with a large dose of short-term heartburn and individual stock failures. That’s why the bargain list represents a starting point for further research rather than the final destination.
Over all, the Canadian market appears to be reasonably priced at the moment. While it might suffer from a real estate crash or some other calamity, a well-diversified portfolio of Canadian stocks stands a good chance of beating a diversified bond portfolio over the long term.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.