Is RIM a broken growth stock? Should Magna be dropped like a sack of potatoes for its bad corporate governance? And what’s a value manager doing with gold? These are some of the questions the panelists on the “Focus on Stocks: Weighing in on the Winners” session answered.
Giving their views on stock picks in the context of their investment styles were Daniel A. Bubis, CFA, president and chief investment officer, Tetrem Capital Management, a contrarian value manager; Suzann Pennington, a self-regarded classic value manager with Mackenzie Investments; and GARP manager Ted Macklin, managing director, Guardian Capital LP.
Considering Canada’s small market size, it’s no surprise value and GARP managers sometimes agree on stock picks, despite having different investment styles. However, Pennington asserts that market-cap mandates can lead to wider divergence between the two investment camps.
“How deep of a value manager you are will be influenced by the universe you have,” she says. “If I were managing a micro-cap portfolio, I would be able to look at those really deep value types of valuation measures, whereas even in my 400-stock universe, my managers are truly value managers, but they’re not the deep-deep value like you get in a micro cap.”
Current vs. future expectations
One of the key differences between value and GARP managers, says Pennington, is that value managers will base most of a company’s valuation on what’s reasonably known at the time, whereas GARP managers will build more of a company’s future expectations into valuing the stock.
“A true value manager doesn’t make assumptions of what may or may not happen in the future,” she says. She believes Research in Motion Ltd.’s (RIM) ability to innovate is too uncertain. Considering the company’s declining valuation, she questions whether the company is a broken growth stock, such as Nortel, or a value pick.
In contrast, Macklin, true to his discipline, is giving the company the benefit of the doubt because he sees promise in its ability to be a leader in its sector.
“RIM is trading currently at a little less than 10 times earnings. I believe that stock will grow easily 20%. And that’s really growth at a reasonable price,” he says.
Sometimes there’s a good stock from all perspectives. All three managers, for instance, favour Potash Corporation of Saskatchewan (POT), albeit for different reasons.
For Pennington, Potash is a value investment, because its good news hasn’t been reflected in its stock price, thereby allowing the fund to trade at a deep discount.
“The stock price hasn’t really moved up in the market recovery. We found the stock is trading at a significant discount to the market value, to the replacement value of assets,” she says.
Stock price is not everything for Macklin; there are also macro factors most value managers don’t consider. With Potash, there’s the emerging-market theme.
“With the emerging [market] consumer comes a changing diet, which typically incorporates a higher protein content, [which] in turn requires an increased fertilizer input. There’s a secular move there that favours nutrients. Obviously, China [and] India are the driving influences there.”
Another reason for owning it, he says, is the fact that the cycle for commodities should be very favourable right now, given we’ve already seen the pricing peak in the fertilizer bubble.
Graham vs. Buffett
In light of the controversial corporate governance issues surrounding Magna International Inc. (MG.A), Pennington says she’s not touching the stock. And Macklin says he’s disowned it since 2004 to 2005 for the same reason.
Pennington says the corporate governance issue falls into the category of disconfirming evidence – material facts that have unknown effects on shareholders and on the stock’s fair-market value.
“I can’t quantify the impact of what they can do because they’ve done things that could be detrimental to shareholders. So I can’t quantify it; I’m not comfortable the fair market value is accurate,” she says. Her accounting for management is aligned with the view of the famous value manager Warren Buffett, who added value for a quality management team.
With respect to Magna, Bubis, also a value manager, is of the same view as Benjamin Graham, the grandfather of value investing. Graham said the financial statements already reflect the management team’s quality.
“I think they’re the best on the planet [in terms] of what their core business is. And they’re exiting the downturn with an increased market share,” says Bubis.
“[Magna] trades at a discount to companies I don’t think are nearly as good as they are. So our view is the governance was appropriately discounted into its share price. But if the governance issues weren’t there, the [stock] would be trading at a significantly higher valuation.”
Gold – where’s the value?
With gold stocks, all three managers break from tradition. Macklin says no one can justify owning gold based on valuations. Further, as gold companies typically trade at a premium, it’s particularly challenging for value managers who normally look for discounts.
All three managers agreed that valuing gold companies is a challenge because traditional measures such as price-to-earnings ratios can’t be used. But they all agree the sector is needed to hedge risk.
“Gold behaves very differently from any other sector we’re able to invest in. It actually tends to smooth the performance returns of a portfolio,” says Pennington.
“So gold is a very welcome addition to a conservative portfolio because it’s so anti-correlated to other possible investments.
“From a portfolio construction perspective, I would actually like to hold gold at all times. From a stock-picking perspective, the way we value gold as value managers is a combination of net asset value and option value of gold in the ground.”