Exploit Canada’s obscurity

Exploit Canada’s obscurity

Our goal is to find underpriced assets. Where should we look for them? A good place to start is among things that are:

-          Little known and not fully understood;

-          Fundamentally questionable on the surface;

-          Controversial, unseemly or scary;

-          Deemed inappropriate for “respectable’ portfolios

-          Unappreciated, unpopular and unloved;

-          Trailing a record of poor returns; and

-          recently the subject of disinvestment, not accumulation.

Howard Marks

Stephen Takacsy, CIO at Lester Asset Management, says the really deep discounts in Canada have little to do with industrial sectors and more to do with the size categories.

“No question, in Canada small- and mid-cap are trading at a huge discount, and that’s where you’ll see the differences — by market cap and also by liquidity. That’s where we get big discounts,” he said.

As an increasing number of investors opt for passive, index-based strategies, Takacsy says that small-cap stocks — and particularly those in Canada — are being ignored.

“They’re less liquid, so the big institutions can’t buy them and the ETFs don’t own them,” he said. “They’re not part of any basket. That’s where you find the bargains.”

Takacsy points, for instance, to one of his proudest investments: winemaker Andrew Peller Ltd. Five years ago, the stock was trading at multiples around 4x. Since then, it has jumped over 300 per cent.

Be wary of the herd

We tend to think of modern markets as being ultra-efficient, led by supercomputer algorithms that can spot valuation gaps and exploit them instantly — but that’s far from the truth.

Even obvious discounts are often ignored for months or years, because the market tends to move like a herd, says Takacsy, with capital flowing in and out of regions as macroeconomic conditions change.

“Foreign investors get hot and cold on Canada,” he said. “If it’s not doing well, they pull their money out in a panic. And then when it is doing well, the plow back in.”

What that means for a bottom-up value investor is that cheap stocks can stay cheap for a long time, but eventually some major event turns the tide.

Tax cuts and deregulation in the U.S. have ignited markets to the south in the past year. Investors in Canada should be on the lookout for similar indicators — like rising commodity prices, surprise rate hikes or favourable trade deals — that will attract investment to discounted equities.

Source

Financial Post