Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

With third-quarter earnings releases in full swing, particularly in the U.S., results are beating forecasts and ever-so-slightly exceeding last year's results for the typical company, yet investors' reactions have been very subdued. Our portfolios remain conservatively positioned, with a primary emphasis on well-capitalized, high-quality businesses versus credit-dependent, or deeply cyclical companies. We selectively added energy exposure to portfolios last month, while taking profits on some of our Canadian consumer staples companies. We also made several within-sector switches within the last month, trading better for best-in-class, in each instance. 

We expect central bankers on both sides of the border have finally reached the peak in overnight interest rates after more than a few head fakes on the way there, but investors expecting a rapid 180-degree pivot back to cutting rates in the near term are likely to be disappointed. The longer monetary conditions stay tight and restrictive, the greater will be the slowdown in economic growth, with the pressures felt most acutely in cyclical, discretionary businesses. These are the areas where we are focusing our research, with the intent to buy “trophy” businesses on sale amidst economic weakness and subdued investor risk appetite, as both of these are excellent contrarian indicators.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

TOP PICKS:

Alphabet Inc (GOOGL NASD)

Google is the undisputed leader in online advertising with its “pull” strategy search model versus social media platforms using “push” advertising. Google’s moat is deep and wide driven by its network effect, not only with search efficiency but also with YouTube content creation/consumption, as well as its dominant market share with the Android operating system and workspace driving growth in the smaller cloud services business. All of Google’s businesses are growing via market share gains and long secular trends, but specifically, we see material upside in its leading generative AI position as this makes its data more valuable over time with improved monetization. The business is in a sweet spot in terms of earnings momentum with easy comparisons versus prior year results for the next several quarters before fading down toward a still very robust sustainable growth rate in the high teens. Trading just over 18 times earnings – an unusually deep discount to its 10-year average multiple of 20.4 times, we see both good value and growth in the stock at current prices.

Intact Financial Corp (IFC TSX)

With a 20 per cent market share, Intact Financial is the largest property and casualty insurer in Canada. Intact underwrites auto, home, commercial and specialty insurance policies and is best known for the efficiency of its operations. It is also known for consistent underwriting profitability which enables it to target a return on equity five per cent higher than its rivals and which currently stands at 15 per cent. As a consolidator of the fragmented insurance market, Intact has grown earnings at a 12 per cent compound rate over the last decade. Long-term forces like climate change and rising property values advantage Intact through higher policy premiums on higher insured property values and over the medium term a “hardening” (i.e. premiums are rising steadily) property and casualty insurance market is providing a significant tailwind to their results as is the benefit of reinvesting their $30 billion bond portfolio at much higher yields as interest rates rise.

Dollarama Inc: (DOL TSX)

Dollarama is Canada’s largest dollar store chain with over 1,500 stores and plans to grow to 2,000 in the coming years. Its key competitive advantages are procurement and merchandising which allows it to price extremely sharply, an ability to secure high-traffic locations at low cost as well as operational efficiency within stores and distribution centres. Growth requires very modest capital and is easily financed internally such that the company generates over $700 million of annual free cash flow, much of which it returns to shareholders via dividends and share buybacks. Dollarama has grown earnings at a compound rate of 19 per cent over the last decade and should continue to grow at a mid-teens pace in the coming years. The company’s majority stake in its Central American joint venture, Dollar City, further extends and accelerates its growth in fast-growing economies where modern retailing is in its infancy.

PAST PICKS:

Alibaba (BABA NYSE)

• Then: US$119.86
• Now: US$82.35
• Return: -31.2%
• Total Return: -31.2%

Fairfax (FFH TSX)

• Then: $811.84
• Now: $1135.04
• Return: 39.9%
• Total Return: 39.9%

Fortis (FTS TSX)

• Then: $55.87
• Now: $55.39
• Return: -0.86%
• Total Return: 2.17%

Total Return Average: 10.87%