Domestic investors have every right to be nervous about the approaching TSX profit-reporting season as U.S. earnings results pour in at mediocre levels. In an effort to help investors hoping to sidestep the American profit slowdown, I went hunting for Canadian stocks with the strongest earnings trends and attractive valuations.
The stocks in the accompanying table are the result of a close look at earnings revisions and price-to-forward-earnings ratios for all companies in the S&P/TSX Composite Index. I screened for forward P/E ratios that are significantly more attractive now than at the beginning of October.
This stock screen should be considered as a guide to further research rather than buy recommendations in themselves. But the hope is to uncover stocks representing the best of both worlds – cheaper and faster growing.
The companies in the table are ranked by the percentage increase in consensus profit forecasts during the past three months. The column at the far right indicates the amount of improvement in forward P/E multiples (for each company’s current fiscal year) since Oct. 1, 2018. For the first company on the list, for instance, energy services provider Pason Systems Inc. saw a three-point decline in P/E ratio – from 26.1 times at the beginning of October to the current 23.1 times earnings.
The final list involves numerous market sectors, but resource and technology stocks dominate. Pason Systems has seen the biggest percentage increase in profit expectations in the past 90 days at 25 per cent.
Labrador Iron Ore Royalty Corp. is the second name on the list and an interesting case. Analysts have raised profit expectations by 13.5 cents in the past three months, but have dialled back optimism back in the past month. The four-week change in forecasts has seen a drop of 11.5 cents a share. Labrador has seen forward P/E ratios improve by more than four points since October.
The results for Shopify Inc. look dramatic at first but are more of a cautionary tale. The forward P/E ratio showed a remarkable 78.5-point improvement, but the actual nominal increase in earnings expectations over the past three months is marginal at one half of a cent.
Shopify still gets credit for an improving outlook, but companies in which only a few cents in profit per share is expected can show deceivingly large improvements in valuation levels for only small changes in earnings forecasts. On the table, this is also evident with Bombardier Inc., where a one-tenth of a cent improvement in the earnings outlook accompanied a big drop in forward P/E ratios.
It’s important to note that profit forecasts are not solely responsible for the change in valuation levels. Market volatility has seen the price of most stocks on the list drop significantly and often this price decline is more responsible for the better multiples than the improving earnings outlook.
The numbers on the table might tell an incomplete story about a stock price’s future in numerous ways. In the case of the energy and mining stocks, for example, the steady stream of data suggesting a global economic slowdown have darkened the outlook for oil and metals demand, and current lower valuation levels and stock prices could be here to stay for a while. Fundamental research is definitely required along with a critical interpretation of the numbers before investors make any portfolio transactions.
That caveat aside, there is still hope that the table includes stocks that are unfairly beaten down and positioned for a strong recovery as profit growth improves.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.
Scott Barlow