Canadian Bargain StocksBy Nate Tobik, Guest Contributor

I was at an event in Toronto two years ago listening to Sam Mitchell, a Managing Director of Hamblin Watsa, the investment arm of Fairfax Financial (FFH.TO) when he made an interesting comment.  He said that in their decades of investing experience they’d come to the conclusion that one of the best investment strategies an investor could undertake was to sit tight during a bull market and wait for a crash.  When a crash came along buy as much as possible and then sell into the bull market.  It’s a fascinating strategy, and one investors can take advantage of today.

If you are waiting for a crash you have to look no further than Canada.  The Canadian market is in recession territory and investors are abandoning Canadian stocks in droves in search of better returns elsewhere.  Savvy investors should take note of Mitchell’s advice and look for opportunities in markets that are distressed, rather than look to buy stocks in markets hitting all time highs.

Investors make their money when they buy.  The lower the purchase price to either a tangible value, or a future stream of cash flows the better the return for the investor.  The problem is that it’s hard to invest when prices are low.  Headlines scream “sell” and investor interest is at all time lows.  The Canadian market headlines couldn’t be more dire, and as investor interest is non-existent, now is the time to buy.

The Canadian TSX, the measure of the broader Canadian market is down 15% over the past year, and down 18.4% from the highs of September 2014.  The Canadian small cap index has been hit even harder, down 19.64% over the past year and down 40% since 2011.  The Canadian Small Cap Index chart is one brutal slog of dips that descend lower and lower and lower.  These declines are after the market dives in 2008.  Investors in Canada have been hit twice in rapid succession, once in 2008 and then again recently.

Finding the Right Bargain Stocks in Canadian Markets

As Sam Mitchell would say buying during a crash is when money is made, and now is the time to be looking to Canada for bargains.  The trick is finding the right type of bargain stocks.  The last thing an investor wants to purchase in the midst of a market rout is a value trap, or a stock described as a falling knife, one inflicting deadly cuts as it descends.

There are 3,799 publicly traded equities in Canada, and 2,910 of those have market caps that are less than $350m.  These smaller companies are overlooked by investment analysts and are tough for larger funds to invest in.  These are the stocks that turn everyday investors into legends.  The problem is for many of these companies their fortunes depend on the future of the commodity markets.  Of the 2,910 companies that reside under a $350m threshold 1,782 of them are non-resource companies.  This is an interesting statistic because the impression investors have of Canada is that their market is dominated by resource companies.  Yet in the small cap space only 38% of companies have fortunes tied to resources; a high number, but not the majority of the market.  It’s these 1,782 companies that are overlooked and neglected by investors.

The question you should be asking is “where is the value?”  The answer is a resounding “yes”.  In the Canadian small cap space there are 502 companies trading for below book value.  Another 288 companies reported year over year revenue growth that exceeded 10%.  I could go on with other metrics such as P/E, high ROE, low EV/EBITDA, and for each there are hundreds of small cap Canadian companies that match desirable numbers for these metrics.

If the pool of opportunities wasn’t enough, there’s a second aspect to Canadian investing that’s very attractive to Americans; it’s that Canada’s currency is on sale.  Remember a few years ago in 2011 when the Canadian Dollar hit parity with the US Dollar?  In 2011 a greenback was worth the same as a loonie.  That situation has now reversed – from parity the loonie has declined to $0.7245.  This means each Canadian dollar only buys $0.7245 of an American Dollar, but it means the opposite for Americans.  Each US dollar has $1.34 worth of buying power in Canada.

The currency tailwinds mean that those cheap companies are even cheaper when purchased in US Dollars.  It’s as if these Canadian companies are selling at a double discount for Americans, a discount to intrinsic value and then a second currency discount on top of that.  It is a good time to be an American looking for value in Canada!

If you’re worried about currencies going the other way, and they eventually will it’s cheap enough to hedge currency exposure.  That means you can lock in these low prices until you decide to sell and exit the position.

Now is the time to be looking north of the border for investments.  If you’re not sure you want to spend hours in front of the screen, consider attending The Microcap Conference in Toronto on April 11th and 12th.  The Microcap Conference pre-selects some of the best Canadian small cap companies to present, along with well-known speakers and time for ample networking.

Nate Tobik

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