Wednesday, 27 August 2014

Canadian Equity Market Darlings and Dogs: August 2014 Update

The days and weeks have been flying by in a very upbeat Canadian stock market this year. It's time for our semi-annual look at the Canadian equities market to see which sectors and companies the market loves (the Darlings) or shuns (the Dogs). Is it even possible to have Dogs in such a strong market? The answer is yes, based on the relative weightings of sectors and stocks in two ETFs:
  • the iShares S&P/TSX 60 Index Fund (TSX symbol: XIU), which selects its holdings and weights based on market capitalization and thus tracks market sentiment, against 
  • the iShares Canadian Fundamental Index Fund (CRQ), which chooses holdings based on past hard accounting results likes sales, dividends, cash flow and book equity value
We will also examine interesting changes in the Darlings and Dogs from previous comparisons in February 2014August 2013February 2013August 2012January 2012June 2011 and the original post in April 2010.

The Numbers
The table below shows the companies and the sectors colour-coded - Darlings in Green and the Dogs in Red. The table also shows the change in internal weighting over the past six months for each ETF, which tells us stocks and sectors that have been moving up or down, either in terms of price (XIU) or fundamentals (CRQ). The bigger shifts are highlighted in Bold.
(click on table image to enlarge)

Adjustment for differing numbers of total holdings in XIU and CRQ - As a cross-check to be sure the sector differences are not due to the fact that CRQ has 29 more holdings than XIU's 60 (which might tend to result in XIU being more concentrated and have higher individual percentages than CRQ) we've re-calculated weights for CRQ using only its top 60 holdings.

Adjustment for differing numbers of holdings in sectors by XIU and CRQ - A second adjustment takes account of the fact that XIU and CRQ hold a different number of stocks in almost every sector (see table for details) and thus the weight of the sector in the ETF may be tilted upward or downward. e.g. XIU holds 10 Financials stocks but CRQ has 14. We've therefore adjusted XIU's weightings to account for the extra or missing stocks, as one of the columns shows.

Adjustment for relative size of holdings in XIU and CRQ - In this edition we've added a further refinement to take account of the fact that sectors and stocks vary a lot in their size within each ETF. For instance, the second largest stock, the Toronto Dominion Bank makes up 7.49% of XIU, while the 20th largest stock, Sun Life Financial is much smaller at only 1.76% of the ETF. Sun Life's 0.41% difference in weight between XIU's 1.76% and CRQ's top 60 stock adjusted 2.17% is much more significant relative to its size than TD's 0.48% difference. We have thus created two new columns outlined in double-blue lines to show differences in sectors and stocks relative to their size. In several cases this adjustment changes the picture dramatically - for the Financials, Energy, Materials and Information Technology sectors and three banks - TD, Bank of Montreal and Scotiabank, plus Brookfield Asset Management and Goldcorp.

Financials - Continuing the trend we noted a year ago, the alignment of the market view and the fundamental view is quite close. Today there are no Darlings amongst Financials, and the Dogs - Bank of Montreal (TSX symbol: BMO), CIBC (CM), Manulife (MFC) and Sun Life (SLF) are not nearly so negatively considered as other sectors and companies are loved.  That CRQ continues to have a much heavier weighting in our table in the Financials seems to be a quirk of XIU's construction.  Several Financial companies that are in CRQ such as Intact Financial, Great West Life, Power Financial, Fairfax Financial Holdings don't even figure in the XIU portfolio even though those companies are firmly within the top 60 largest market cap stocks on the TSX.

Energy - There has been further convergence of market view with fundamentals to the point that the sector overall within XIU is so slightly less weighted - only 12%. less -in relative terms that we cannot really call it a Dog. CRQ still has more weight in Energy than XIU, but it is not so much as to make it a Dog. One big company - Enbridge (ENB) - is still a market Darling, while Canadian Natural Resources rejoins the Darling ranks after a few years absence. Cenovus (CVE) has emerged as a new Dog, replacing Encana, which has now shrunk so much in both XIU and CRQ that it dropped out of the top 20 stocks in both.

Materials - This sector has moved from being a Darling to a neutral position. Perpetual Darling Potash Corp (POT) remains so with a stock price at a level significantly higher than accounting fundamentals justify. Former Darling Goldcorp Inc (G) is now neutral. Apart from those two stocks, the difference in weight between XIU and CRQ is due to the fact that XIU includes several miners excluded from CRQ.

Telecommunications - The two DarlingBCE Inc (BCE) and Telus (T) continue to be the object of market desire, being vastly overweight in XIU compared to CRQ, though Telus has been displaced in XIU's top 20 by even faster growing stocks.

Industrials - Our comments of February still apply exactly - Canadian Pacific Railway (CP) continues its resurgence as a Darling which, along with perpetual Darling Canadian National Railway (CNR), makes the whole sector so.

Consumer Discretionary - This sector is now completely neutral. Even the former Dog Magna International (MG) is now valued the same in both XIU and CRQ.

Consumer Staples - Not much is going on here either. The sector remains neutral as in February. Individual companies themselves remain in balance too.

Health Care - Darling ! The market is still over the moon in love with both companies in this sector - Valeant Pharmaceuticals (VRX) and Catamaran Corp (CCT). By fundamentals, Catamaran is too small even to be included in CRQ's top 60 yet it is the 40th largest holding in XIU. The passion may be starting to ebb though. Valeant's weight in XIU dropped the most of any stock since February and Catamaran also fell eight places in the ranking from 32nd.

Utilities - CRQ puts a lot more weight in this sector. The market thinks the sector and individual companies Fortis (FTS) and TransAlta (TA) are Dogs, despite all the adjustments we make. Is there investment opportunity here?

Information Technology - Blackberry (BB) is an interesting case. It continues to become more of a Dog as its market cap in XIU has continued to drop but its fundamental weight in CRQ has recovered somewhat.

The Darling and Dog sectors and stocks since 2010
Using the same benchmark as February, most sectors and companies are still in the same position of being either Darlings - Materials (Potash Corp and Goldcorp), Industrials (CN Rail and CP Rail), Healthcare (Valeant) and Telecommunications (BCE and Telus) - or Dogs - Financials (Manulife and Sun Life)Utilities and Consumer Discretionary

However, using our new relative benchmark, Financials, Energy and Consumer Discretionary are no longer seen as Dogs, nor would they have been in February. Consumer Staples and Materials would have been Darlings in February but are not now. All those sectors we now label as neutral.

Telecomms and Industrials are consistent Darlings while Utilities and Information Technology are consistent Dogs.

Our table shows the classification based on both the old method and the new relative revised method of distinguishing the Darlings and the Dogs.
(click on image to enlarge)

How do the Darlings and Dogs stocks' numbers look?
We entered the thirteen stocks from the top 20 biggest in XIU that are either Darlings of Dogs in a Globe&Mail WatchList to see recent stock and company financial performance. We got a shock. The table screenshot below shows that the one-year total return (stock price plus dividends) for all the companies, Darlings and Dogs both, was positive. Counter-intuitively, several Darlings, like Potash Corp, BCE and Valeant did worse than the XIU average, while only one Dog did - Cenovus. The only company with net losses is one of the Darlings and the most extreme Darling at that - Valeant!

Meanwhile, Dogs Manulife, BMO and CIBC, apart from being solidly profitable, sport reasonable dividend yields and attractively low Price to Earnings ratios. They appear to be worth a look for individual stock investors.
(click on table image to enlarge)

XIU and CRQ, or other broad market funds can also be used directly as diversified investments for those investors who do not feel confident, or who don't have the time, to investigate individual stocks. The differences in weightings and holdings are only a couple of aspects in comparing the two ETFs. See our previous posts reviewing Canadian equity ETFs herehere and here.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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