As the TSX Composite continues to flirt with all-time highs, and the S&P 500 looks to be even more expensive, it’s slim pickings for value investors. The default solution for most investors has been to simply pay up for quality stocks. The thought process there is, better stocks tend to hold up during periods of market weakness. In other words, the finest companies allow an investor to capture the upside while protecting against the downside. But value stocks do exist in today’s market. They’re just a little harder to find, and, admittedly, they do come with a number of issues….
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As the TSX Composite continues to flirt with all-time highs, and the S&P 500 looks to be even more expensive, it’s slim pickings for value investors.
The default solution for most investors has been to simply pay up for quality stocks. The thought process there is, better stocks tend to hold up during periods of market weakness. In other words, the finest companies allow an investor to capture the upside while protecting against the downside.
But value stocks do exist in today’s market. They’re just a little harder to find, and, admittedly, they do come with a number of issues. If these stocks can successfully turn themselves around, big gains will likely follow. It’s hard to argue that already expensive indices or investor favourites have similar upside potential.
Here are three of Canada’s cheapest stocks.
Hudson’s Bay Co. (TSX:HBC) is a mediocre retailer with a very attractive real estate arm attached.
Let’s talk a little about the retail part of the business first. HBC is struggling because it’s been posting somewhat lacklustre results. Same-store sales for the all-important holiday quarter were down 1.2%, mostly because of weakness from the company’s outlet stores as well as its new European division. The decline was even worse if we factor in differences in exchange rates.
The good news is, investors focused on the retail part of the business are driving shares down. As I type this, shares trade hands at less than $12 each. The real estate alone is worth $37 per share, at least according to a presentation at the 2016 annual meeting.
Of course, the value of real estate means nothing without a way to extract the value of it off the balance sheet. HBC is working on two joint ventures that will do just that. One will consist of the company’s Canadian properties, while the other will have American and European properties. The only question is when will these ventures become publicly traded, thereby unlocking value.
When that happens, look for shares to head substantially higher.
Despite people saying Canadian housing could be in a bubble — especially in Toronto — there are some surprisingly cheap real estate investment trusts out there.
Perhaps the cheapest is Morguard Real Estate Inv. (TSX:MRT.UN). Morguard has a current share price of $15.25, while the company’s most recent reported book value was $25.66 per share. That’s a discount of more than 40%. It’s the equivalent of paying 60 cents for each dollar of net assets.
Most of the time a stock trading at such a discount has nonexistent earnings. Morguard is the exception. It delivered $1.87 per share in funds from operations in 2016, putting shares at just 8.2 times the equivalent of earnings. It easily earns enough to afford the 6.3% dividend.
First National Financial
First National Financial Corp. (TSX:FN) trades at just eight times trailing earnings, despite growing like a weed.
The company, which is Canada’s largest non-bank mortgage lender, has grown to the point where it has nearly $100 billion worth of mortgages on its books. Revenue grew 15% in 2016 with net income hitting $3.28 per share.
Even if new mortgage rules take a bite out of new loan originations — and with it, First National’s top-line growth — shares are still cheap enough that good things can happen to investors who get in at today’s bargain prices. The company also pays a generous $0.14 per share monthly dividend — good enough for a 6.3% yield.
The bottom line
Admittedly, all three of these companies have warts. HBC is struggling with lacklustre retail sales. Morguard has significant exposure to Alberta, which is struggling amid crude oil’s massive decline. And much of First National’s mortgage volume comes from Toronto — a market many declare is in a bubble.
But you can’t argue with these valuations. All three of these stocks are trading as though the worst-case scenario has already happened. Patient investors who load up on all three could one day be sitting on some significant capital gains.
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Fool contributor Nelson Smith owns shares of Hudson’s Bay Company.